May 07, 2010

The danger of accepting other people’s money

I’m writing to you from The Association Of Corporate Growth (ACG) annual conference in Miami Beach where I was invited to be a panelist on Bo Burlingham’s roundtable about the pros and cons of accepting outside investment in your company.

Along with Bo, who is Editor-at-large for Inc. Magazine, my fellow panelists included Martin Babinec, founder of Trinet, which helps fast growth companies manage their HR issues and pay their employees.  Martin has raised a total of $100 million in outside capital through six investment rounds. JW Ray co-founded, which is a $40 million dollar software business that allows companies to offer their employees training via their computer at work. accepted investment money from friends and family to get started and then took a private equity investment in 2005, which they lived to regret.

The audience was made up of private equity investors and venture capitalists who have a strange job: they need to bat away hundreds of companies that are desperate for money while trying to convince the one business that doesn’t really need their money to let them invest.

My job on the panel was to provide the perspective of a business owner who chose to grow a business more slowly without accepting outside investment.

Early on, Martin allowed a publicly held company to buy half of Trinet in exchange for a $4 million dollar investment. The chairman of the corporation joined the Trinet board and would only agree to sell his shares in return for a valuation typical of a public company (i.e. double digit multiple of earnings). Martin found a venture capitalist to pay the rich premium his strategic investor was asking for, only to go from the frying pan to the fryer. His new investor started pushing Martin to go public from their first board meeting.

At, JW and his partner accepted a private equity investment in order to fund a growth-oriented budget they had prepared. At their first board meeting after the deal closed, their new private equity investor refused to approve the pre-agreed budget explaining they invested in “cash cows not pigs”.

Soon after, the private equity partner made a second investment in one of’s competitors leaving them with a board member who was part investor, part spy for the competition. JW and his partner spent the next five years trying to get the investor off their board.

What struck me in listening to Martin and JW was how much their day-to-day experience of company-building changed once they accepted outside capital. They went from focusing on customers, products and employees to preparing for (and recovering from) quarterly board meetings, disputing budgets and obsessing over deal covenants.

It almost sounded like they had traded their business for a job.

To me, entrepreneurship is about creating something from scratch while bush whacking through the forest of problems and decisions on your own. It is a capitalist escapade of sorts and like any adventure, best enjoyed when you have the freedom to roam.

Contrary to popular rhetoric of the moneymen I met today, I’m happy I kept 100% of a smaller pie that I controlled rather than a potentially more valuable stake in a company I didn’t.

How about you? Would you rather own a small chunk of a big company or a big chunk of a small company?

Here are some new articles on building a company you could sell:

Time to Reset Your Business?

~ published May 4, 2010 The Wall Street Journal

I recently heard about a dentist offering Botox injections as a way to jumpstart his recession-weary dental practice. Last weekend, I jogged past a tanning salon offering teeth whitening. Dentists offering to tighten your smile and tanning salons offering to whiten it? What’s going on here? Increasingly, business owners are starting new product and service lines in a desperate attempt to pick up much-needed revenue.  » more

Is your Service Business Too Squishy?

~ published May 4, 2010 Inc.

David Ogilvy, the famous advertising pioneer, described the biggest problem with a service business in a memorable way. “The assets go up and down the elevator every night,” he said.

Because people are the main asset of most service companies, these businesses are vulnerable to human frailties: At times we all get sick, tired, cranky, fickle, and jealous. This makes the management and operation of a service business somewhat unpredictable—which makes selling it all the more complicated.

When you go to sell your business, a buyer will be looking for predictability, which is why service businesses can be tough to value.

To create a service business you can sell, do whatever you can to make your business look like it has a product and a formula that predictably delivers results.  For example, Peter Turpel went from consulting with companies about how they used their phone systems to developing the “Phone on Hold Marketing System,” which offers businesses various options for handling customer calls (e.g., music, call routing). Turpel moved from consulting personally with customers to creating products around his knowledge so that the business appeared more tangible. » more

The risks of selling companies to employees

~ published April 27, 2010 The Globe and Mail

One of the best parts of writing this column and my books is hearing from you, the reader. So this week, I’d like to turn the column over to your questions. Please use the comments area below to ask about building a company you could sell or to provide a comment you’d like me to address.

Q: “What are the risks involved in selling my business to my employees?”

A: When selling a company to employees, most business owners end up guaranteeing some of the loan the employees use to buy the shares. Your biggest risk is that your employees will not manage the business well on their own and your old business will end up in financial trouble. If the business defaults on its commitments with you as a guarantor of the loan, you could end up owning the business you thought you had sold. » more

When to say you’re selling

~ published April 28, 2010 The Globe and Mail

Q: “How and when do I tell my employees that I’m considering selling my business?”

A: I would recommend drawing a distinction between telling your management team and telling the rest of your employees.

In order to minimize an earn-out, you need to present a potential acquirer with a management team (not just you). That way, the acquirer can get comfortable with the team of managers who will be running the business after you leave. Before you start meeting seriously with buyers, you should tell your managers. To get them excited, you can offer them a “success bonus” tied to closing a deal, paid in two installments: one on the day the deal closes and a second tranche on a future date, provided they are still employed by your company and its new owners.  » more

Help! My company is a cash hog

~ published April 29, 2010 The Globe and Mail

Q: “You talk about charging up front as a key part of creating a valuable and sellable business. I sell to retailers, and charging up front would be a non-starter. My customers are insistent on 30-day terms at a minimum. What would you advise?”

A: Creating a positive cash-flow cycle is an important part of growing a valuable business because (a) it gives you the working capital to grow without having to dilute yourself with outside investors and (b) it bumps up the multiple you’ll get for your company because the acquirer will have to invest less cash to run your business. It’s also a lot more fun to run a business that has money in the bank.  » more

  • Rene Lacerte says:

    Great question but I beg to differ with your conclusion. I have raised 9 rounds of capital and have never had a VC push us to sell. All of my investors have been focused on building the business and have provided invaluable advice in that process. Like with most things, I think the answer varies depending on the amount of capital needed to build and who the investor is. Some businesses take serious capital to get started and without the investors there is no ability to roam. And like you say, if your an entrepreneur, “roaming” is the best part. At least for me:)

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