The first thing that jumped out was the enormous growth they were projecting.  Revenues going from 1.6m euro in year 1 to 58m euro in year 4.  Suffice to say i nearly feel off my seat, especially since their current revenues are ZERO!  The next step was to look at the drivers of revenue and to understand even if these numbers were possible.

So when looking at these types of numbers, i always look at the drivers of revenue.  In this case they are pretty simple – numbers of agents x monthly revenues.  Now the business decided to operate on a trial then convert approach.  This can work if the process is streamlined, results are delivered during the trial process and the customer feels like they are getting value for money and thus convert to a paid customer.

In this case, the portal has decided to start charging from the 1 July next year.  So working backwards off their numbers, it was clear that they had to have around 1,500 customers paying in the first month.  However, in June they had only planned to have 2,000 customers on trial.  This means they would have to have a 75% conversion rate from trial to paid!  The problem with this logic was that no one else in the world that uses this approach comes even close to these conversion rates.  Perhaps they best is around 35%.  So, even with a simple 5 min logic check, the projected P&L just doesn’t add up.  Therefore, the valuations used to drive the capital raising also will be overstated.

The bottom line, if you want to get sophisticated investors on, have a realistic model that you are going to raise money against.  Those who know these businesses will see through the assumptions in 30 sec.

However more importantly, investors are really investing in people and if management believe in unrealistic numbers, then their grip on the business is tenuous at best.

If the company does not do this, it runs the risk of disenfranchising their employees and their customers.

The first thing a company must do when tightening its belt is make sure that it is even across the business.  Many businesses are closing departments and firing staff.  However, what they should not be doing is increasing the perks for the executive team – like adding secretaries for senior management, holding expensive retreats at 5 star hotels and continuing to fly business class when it is not needed.  If a company does this, it creates and us and them culture and the employees will lose faith in the management team.  This is not good – especailly in these tough times!

The second thing a company must do is make sure that it is seen to be tightening its belt – especially with its customers.  Whether a company likes it or not, the customers are probably hurting in these economic times and if a company maintains or increases its prices, it is important that they are not seen to be wasting money on internal extravagences – like expensive conferences or management retreats. 

Nothing can disenfranchise a customer more than to be asked to pay more for a product and serivce and then to see those additional fees not being used to improve products and services.  Your business reputation will last long after the financial crisis is over.

We all remember what impression the CEO’s of Ford, GM and Chrysler had on the US public when they flew in private jets to Washington to ask for money!  Not a smart move.

The first issue we come across is that many of the founders are entrepreneurs and more often than not they fit into one of two categories – technologists or marketing guys.  The technologists are usually fantastic at developing new products and servies and will work their butts off to make it happen.  However they sometimes dont understand the subtleties of marketing and sales.  The sales guys, while understanding what it take to sell things, are often over estimate their abilities or the demand for their product. 

The second issue is the cost side of the business.  We often come across business plans that underestimate how much it really costs to make these businesses happen.  They usually underestimate the number of people and more often than not, underestimate the marketing side of the business.   For example i recently had a long discussion about conversion rates and how many leads from a web site were needed to convert into a sale.  The whole revenue plan was built and this yet it was very theoretical.  What they should have been doing is getting on with it and experimenting – not burying themselves in spreadsheets.

Finally, it is often the combination of the first two issues plus the sometimes blinding passion of the founders that lead to unrealistic valuations for businesses.  These valuations often use comparatives to established larger businesses – often those listed.  This is just unrealistic.  The founders need to understand that they have to prove that they have a business and that they are able to grow a business.  Just because it looks good on paper doesnt prove anything.   Also, they need to leave value on the table for the angel investors – as they want to get a 20x + return on thier investment.

So what should they do?

Firstly – be conservative in the revenue projections and experiment early and often to firm up the assumptions with some facts. 

Secondly, think carefully about all the expenses and plan appropriately.  It is better to have too many expenses planned for and not spend them than the other way around.

Finally, in valuing the business, check your ego at the door, and make sure that there is clear value left on the table for the potential investor.  No one is going to pay for value that has not yet been created.

Finally,

• Pay attention to invoices – think about it.  You run a company and you look for any reason not to pay someone elses bill on time.  Therefore why wouldnt they be thinking the same thing.  Make sure all invoices are accurate the first time hey are sent out.
• Stay close to your customers – perhaps a better way to put this is to chase outstanding invoices hard.  Customers will find a way not to pay them and it is important for your business that they do.  Dont be afraid to ask for money – i am sure your customers are doing the same with their customers!
• Outsource debt collecting – the use of an external party to do the debt collection is a good move.  You can only chase people so hard however professional debt collectors (and i dont mean those with baseball bats) are able to focus on collecting the debts.  Make sure that the service and ethics of the debt collectors you engage are aligned with your brand.
• Keep stock levels low- this should be an ongoing requirement for those that do carry stock however it is more important today than ever before.  Think about stock on your shelves as the same as cash in the bank – but far less tradeable.  Managing stock levels is now a critical skill.
• Scrutinise new clients – this is a very timely tip.  Just because someone wants to use your services doesnt mean they will pay.  From time to time we have this problem and it is important that you check out your customers closely.  Even ask for payment in advance.
• Pay slowly – this is the other side of the coin.  Utilise the maximum payment terms available to you so that you can keep dollars in your account.  Remember, others are taking the same approach with you.  Dont abuse the relationship otherwise they will stop serving you – a far less exciting outcome!
• Sell under utilised assets – this is a great tip.  Around the business there are assets that are just not being utilised 100%.  It therefore makes sense to sell these off.  The only problem is that they are unlikely to get a great price in today’s economy.  Still cash in the bank is worth more than an asset that sits around.
• Make sure your financing is appropriate - when people are paying slowly and the bills are mounting up, it is important to make sure that you have enough funding.  You cant delay paying employees so having access to enough working capital is very important.  Failure to do this will result in you having to raise money in a very tough environment.
• Link performance to cash flow - this is very important.  People throughout the business should have their bonuses and performance measurement tied in some way to the cash flow of the business.
• Prepare a cash flow budget – most companies prepare a P&L based on accrual accounting.  This is great when things are good and you are more interested in the high level performance of the business.  However as cash is king, the preparation and constant monitoring of a cash flow budget that truly predicts the movement of cash is critical.  This will act as an early warning mechanism for managment if cash flow is not going as expect.

Following these astute set of observations by Melissa Wilkinson will help any business weather the current economic storm.