I had the misfortune of raising cuckoo capital for my company – complained an entrepreneur about his predicament. „Cuckoo capital?” – I asked back embarrassed about the feared gap in my investment education.  Vulture investors I have heard of and even dealt with, but “cuckoo” sounded something more benign.  Maybe it was behaving as a cuckoo clock, alerting the founder when it was time to pay dividends – I thought.

“He was going to come in as an angel investor” – he explained.  “He promised to help grow the business through strategic initiatives and business development.  A dynamic-looking Harvard educated guy, investing his father’s money, who had sold a manufacturing business in the US. He invested half a million dollars, joining me and other founding partners or our company.

“However, he turned out to have brought us no new clients” – he continued – “and his strategic contribution was a corporate coup.  He conspired with my minority partners to recall me as managing director and demote me to “technical director” with no budget for purchasing equipment or authority to sign sale contracts.”

“My “angel’s” next step was to increase share capital at par value, diluting my shareholding to below 10%. That deprived me of both voting influence and minimized my chances of future dividends.  My investor turned out to be a cuckoo capitalist, whom I nurtured as a partner, just to be jettisoned by him at the earliest opportunity” – he finished the tale.

This story is rare at private firms, but all too familiar at public companies. One example is Steve Job’s firing from Apple by John Sculley he had recruited from Pepsi to run the firm a year earlier with the famous one liner: “Do you want to sell sugar water for the rest of your life, or do you want to come with me and change the world?” But Jobs learned his lesson.  In 1997, he persuaded Apple CEO, Gil Amelio, to buy his company, Next Computer and take him on as presidential advisor, only to replace him 5 months later in a boardroom coup.

“Well begun is half done”, said Aristotle. This is true also for building sellable companies. However, good selling takes another 50% of effort, which takes it to 150%.

Am I serious? How could selling add so much value? Many believe selling adds no value at all. Make a good or well priced product and it will sell itself.

Depends where selling begins and ends.

True, some type of selling adds little if any value. This gives business brokerage a bad name. How much added value is there selling quoted stock? Business brokerage, at its best, is peddling connections. At its worse, classified advertising at the cost of confidentiality.

At the other end of the spectrum, the sale of a company begins before founding or investing in it.  The approach of serial entrepreneurs and better private equity groups: begin with the end in mind. Treat a company as a product and shape and build it to appeal to the eventual buyer, be it a strategic investor (patents, products, position) financial buyer (cash cow-ness, growth) or IPO (image, vision, story).

In the middle is M&A. True, we do not ourselves grow companies, although, often we keep in touch for years advising prospective sellers building and grooming for the sale.  However, our goal is to add as much value as possible in the timeframe of a sale or capital raising process, being typically 6-12 months.

We add value by positioning, marketing, advising, structuring, preparing, correcting, presenting, up-bidding, managing, negotiating, maximizing, troubleshooting, and running the process… and not least, letting the founder/CEO keep building value and maintain numbers by keeping his eyes on the ball, while we tend to the bidders.

Back in the days of compulsory military service, conscription notices ended with the sentence: „bring 3 days cold food to the barracks”.  The idea was sound, ensuring that conscripts were prepared for the worst eventualities.  Entrepreneurs would do well to follow this logic when acquiring companies.

What am I talking about?

Buyers typically bid for targets on a “cash and debt free” basis, meaning that bidders do not wish to be responsible for the debts of the company, but willing to pay extra for any cash in excess of the minimum needed for normal operations. The idea is to prevent sellers from weakening the balance sheet of the target between the offer date and closing.  Otherwise, sellers would withdraw all existing cash and even lever up the company and take that cash too to maximize their proceeds from the sale.

Notwithstanding the cash-and-debt-free clause, buyers may still lose, if they take over the company without a healthy cash balance required to fund upcoming salary or bonus commitments, or if there is declared but unpaid dividends to be honored by the buyer, post closing.  One investor in a currently closing transaction explained to me the “3 months cold cash in the till” principle, to ensure the bidder would not have to start by raising the capital of a newly acquired, cash starved target.

Cash is food, but targets need more. They should be bought with muscles and fat too making sure they are fit to sustain performance. For manufacturing and trading companies stock is the muscle and receivables are the fat, on which the company may live even if there are few new orders during the months after the takeover when the buyer is preoccupied with learning the company.

– Do VC’s help portfolio Co’s other than with cash? – The MD of a potential investee asked me today. Very good question, I thought. If they did not, than VC money was commodity like bank financing. Go to whoever gives you the most money fastest with the fewest strings.

If we ask the funds, this is not at all the case. First, there are the specialist funds. They claim their specialism works for you, but it serves THEM more. Specialism allows companies in their niche to find them faster. Reading up on an industry helps them make fewer mistakes then their generalist brethren. Then, most funds claim that they help businesses with strategic advice and business contacts. As for advice, it is mostly from a former industry fox hired for the board, who prices up his brains by flying business and sleeping Four Seasons. More often than not his advice is corporate than entrepreneurial (here is how we did it at GE) and his contacts have retired with him.

True, the venture capitalist spend time on the board himself, bringing in consultants, checking monthly figures, brainstorm with the CEO… but only his their core business of investing, exiting and raising funds is done.  I recently heard at a private equity gathering in London, that: “70% of the funds don’t pay out carry”. This means that the funds underperform leaving managers without a bonus, living on their 2% per annum management fees. Therefore:

• The more funds under management the higher this fee, so core biz # 1: Raise Money.
• The way to raise a 2nd fund is to quickly invest the 1^st, so core biz # 2: Invest Money.
• By fund raising no. 3, there must have been exits, so core biz # 3: Exit Investments.
• And for a good fund return you must have 1-2 home runs, so core biz # 4: Nurture Stars… and avoid big failures.
• The way not to have big failures is to intervene when things go wrong, so core biz # 5: Fire Fight!
• Finally core biz # 6: Support portfolio companies.

Do VC’s strategically support?

Yes, when they have nothing better to do. Notably, for 2 years after the financial crisis broke, VCs dared not invest and had ample time to restructure and groom portfolio companies. Now, that the war is over, they  must quickly return to their core businesses of investing, fundraising and exiting… if they don’t want the music to stop and go back to be a banker or hand to mouth consultant.

In recent years, there has been much sabre-rattling about unethical entrepreneurs using the veil of secrecy of offshore paper companies.  The outgoing government introduced legislation restricting the use of foreign parent companies, unless they are transparent vehicles conducting operating activities. Entrepreneurs must show what they have, or else…

First, I was surprised that politicians were so keen to abolish a tool of which they had been the foremost beneficiaries. After all, a successful entrepreneur need not be shy of having created value and harvested its rewards. They worked hard, risked hard and reaped.  This is the natural way of things.  CFC legislation prevents them not, from managing and investing their wealth abroad thorough legitimate asset management structures.  It is the politicians, with relatively modest official salaries, that need to hide the loot. What will they do with the demise of paper companies?

And then it dawned on me. People in power do not need to hassle with foreign incorporations, bank accounts and Dubai shopping trips via Vienna.  They do not need to study tax rules, legal structures or learn a foreign language.  As simple as a Rubik’s cube: use a strawman (front man) from the privacy of your armchair.  He will be happy to sign for you as beneficial owner for a daily hot soup, a driver and a status. (The self-delusion of respectability.)  He will do your laundry and dishes too while he is at it.

The “naive” advisor is a convenient partner for hard headed clients. He is 100% loyal to his master, drinks his words and lends them his “credibility”. The “naive” advisor is not concerned by accounting, economics or logic. He tailors financial theories to his client’s wishes, so that he can serve him better. He sees his role in packaging the messages uttered by his client in order that it might confuse the other party into accepting his win-lose proposition.

The “naive” advisor never loses his cool as business is unemotional. He is on a mission to sell whatever his client wants.  Whether it’s in his best interest or not, is none of the “naive” advisor’s concern. He is paid to support his client not to argue with him.  If the point doesn’t get across, the other party is to blame. Probably, too stupid to understand.

The naive client loves the “naive” advisor for his fighting spirit. The “naive” advisor likes the naive client for his culpability, dependence and naivety.  The longer the “naive” advisor fights and loses, the more the naive client depends on and pays him. Their joint defeats bond them together in eternal friendship.

It’s a commonly held belief that venture capitalists are risk takers, willing to gamble on new ideas. My experience is just the opposite. Ideas are dime a dozen and in themselves make people poor more often, than rich.  To paraphrase Bill Clinton: It’s the execution, stupid!

The value is there with the people who can execute ideas.  Best if the idea is borrowed or not new, in which case the chances are higher that the dead end streets had already been trodden by the less fortunate explorers, leaving cost efficient lessons for the execution specialist.

But, back to VC’s and idea-investing.  This is certainly a myth in my country, Hungary.  Here hardly anyone invests in start-ups, other than 3F investors (friends, family and fools). The latter category includes dummy money, being grant funds from the EU or the government. It pains no one if lost, but might make its promoters rich… in the unlikely event that such “investments” ever make a return.  It was refreshing to listen to a sober entrepreneur last week, who walked into my office and explained that whatever asset he had bought with EU money is worth only half what it cost.  An example is deep freezing plants, of which many were built from EU grants creating an oversupply and driving down resale values to the hard equity portion.

So how do VCs invest?  Sure, there has to be a sexy investment story, but the decision is ultimately down to the personalities behind it. If the entrepreneur is credible, VCs will chip in. If not, than no matter how good the idea, the moneymen will stay cool.  Even in Silicon Valley, the fast money is for serial entrepreneurs, who had already proven that they could build sellable, IPO-able companies. The due diligence is on people first, ideas second, (numbers third).

Below is a link to the latest newletter of our international organisation, IMAP, including the following articles:

• Latin America: Colombia emerging as global player
• Asia: M&A in China is becoming more interesting
• Europe: High tech activity on the rise in the UK
• IMAP M&A multiples
• PEGging the Market
• Industry trends in M&A
• IMAP’s next international M&A symposium

Please paste the link into your browser. I wish you an interesting read!

http://media.imap.com/IQ/October%202010%20PDFs/OctoberIQ-1.pdf

The other day, a successful retailer said something that struck me:  – We have to make money on everything – he stated matter-of-factly.  It was about using a supplier to finance the costs of marketing and discounting for a sale, but the phrase sounded like a core principle of his company… a benchmark to evaluate every single opportunity… a business philosophy to live by… a discipline.

His company is one of the best in its sector, but attracts little attention. The CEO’s office is clean, but simple, with a plastic promo clock facing the visitor who is sitting at a post-retro, just-above-IKEA quality boardroom table, across a matching cabinet.  The CEO is talking about his no-turnover management team, who routinely work 5 to 9 (rather than 9 to 5), and at weekends, if needed. Given his no-nonsense attitude, the disciplined, diligent and do-it-all-today approach, I might be fooled to be looking at a Chinese company run by locals. No magic, no frills, just more economical, more effective and more efficient in the small details of running and executing its daily business, than its competitors.  Not innovative, but intelligent, doing the basics right… over and over.

“Make money on everything” sounds simplistic, even greedy, but it is the opposite. It is a highly economical approach that calls for efficiency and providing value to customers. It is simple enough for management and staff to live by, to execute day in, day out. The road to profit is not BIG IDEAS, but many little improvements, made happen.  Little hinges swing big doors.

It is so easy to fall into the trap of taking on projects for market share… for keeping idle staff busy… or to grow the top line, hoping economies would eventually take care of the bottom line. Trouble is, such projects often boost costs, complexity and risk too.  “Making money on everything” keeps your feet on the ground.

The term „business angel” conjures up an image of the benevolent investor… helping the aspiring start-up with money, advice and connections to grow his company big.  It so happens, that some angels are less angelic than they seem.  Sometimes they are outright demonic.

The position of a business angel is fiduciary. His qualifications are:  having cash and time to invest, experience and integrity.  Angels are typically former entrepreneurs, having sold out; or big-time executives who cashed their options or golden-parachuted into early retirement. They are usually, between 40 and 70, without the need or desire for full time employment or running a business.  What they are after, instead, is the opportunity to mingle with and contribute to creative, ambitious people. They want to leverage their experience and time into money by helping exciting ideas turn into valuable businesses.  The true business angel is a godsend for a start-up, as he is autonomous, speaks his mind, and acts on principle. Hence his name.

As it happens, occasionally a demon pulls a pair of wings and a glory and poses as an angel. He gives some, but takes more.  He has contacts, but often the wrong type… that harm, rather than help the company. He speaks, but not his mind, but words that manipulate his prey into allowing him to grab control of the company. Such an “angel” is really a parasite, who seeks wealth by feeding on inexperienced entrepreneurs. Fortunately, this ‘wolf-in-sheep-skin’ is easy to uncover. Just put him under pressure and he will crack like eggshell.