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,

My guess is that most business managers around the world are probably thinking the same thing.  Revenues will be flat or falling this year and that the business will have to focus on cutting costs – mostly through letting people go – to maintain profit margins (or minimise losses).  The funny thing is that if most managers in the same industry do the same thing, the status quo will probably be maintained.  The only changes will be that the little guys go out of business but the relative market shares of the leaders will remain steady.

The contrarian in me say that now is the time to acquire businesses – especially those that are poorly financed but in a good market position.  By taking this contrarian approach, businesses will be able to change the competitive landscape – potentially for years to come.

At Classified Ad Ventures, we have established an investment fund and are taking positions in online classified businesses around the world.  We believe that the movement to online classifieds will be accelerated in this down turn – especially as advertisers move away from traditional print media advertising.  At the same time, the current online classifieds businesses have been oversold and are now trading at attractive valuations.

When the economies recover, we believe we will be in a good position to capture much of the upside potential these businesses have to offer.

At the REA Group we purchased 15 different businesses and during that time used a number of different valuation approaches.  These approaches included market values (ie comparative sales), discounted cash flow, revenue multiples, net earnings and EBITDA multiples, and value per customer. 

The objective in the valuation of a business is to work out the value in the hands of the current owners and then the value in the hands of the acquirer.  This give you the overall range and the negotiation objective is to agree a price as close as possible to the value in the sellers hands.  (Otherwise you are giving away too much value to the seller)

However, valuing a web 2.0 business is a different kettle of fish.

First of all when talking about a web 2.0 business, you are usually talking about one with little or no revenues, a focus on signing up subscribers and future promise of advertising or some other revenue potential. 

Now if the business has revenues and expenses and can demonstrate a good rate of revenue growth, then you may have a chance of building an acceptable discounted cash flow model and therefore a clean valuation. 

However, these businesses are usually not that developed therefore the focus needs to be on the number of signed up customers (subscribers), average session time and page impressions.  Using the growth in these numbers, you should be able to estimate the overall growth of the usage of the site over time.  The challenge is then applying an advertising model (or perhaps a paid for subscription model) to the business and then extrapolating some sort of value from that.  (Tough but doable)

Also – these types of businesses tend to have an exponential valuation rather than linear – meaning that the larger the busness is, the more it is relatively worth. 

Of course, the fundamental challenge for any web 2.0 business is will they ever earn real revenues.  The jury is still out on them.

One of the businesses has a new product set that is complementary to the existing product set.  The way we are approaching this merger is to rapidly focus on getting the go to market approach right.

What is a go to market approach – it is the product / pricing / sales and marketing approach to get the product to the market in the most cost effective manner.

We purchased the business on Monday and by Friday the sales team will be training on the integrated product set … how are we doing it?

1. We have flown the leadership team for that business unit into head office for 3 days of solid work
2. They are charged with merging the product sets (from a sales perspective), revising pricing, and getting materials ready for the sales people who fly in from around the country on Friday for a day of briefing.
3. On Monday, the new product set is being sold by the sales team and our industry marketing team kicks in with special offers to target customers

It may not be pretty but it will work.  We would rather get out there and try it than think for ever and a day about what may be.

I will let you know how we go.

Integration is the make or break of any deal.  On paper it may look great but if the people dont want to play ball, then often the value goes up in smoke.  Culture has a lot to do with it and the merging of the cultures is critical.

The way we are approaching the integration of the two companies is simple and one that i would recommend to all people.

1. We have appointed a senior person (direct report to the Chief Executive Officer) as a project sponsor – their job is to make sure that the integration occurs in the agreed time
2. We have appointed a dedicated integration manager who has overall authority to make the integration work – this is a full time role
3. We have clearly identified the org structure / reporting lines / seating etc … to ensure that people rapidly have a new home
4. We have set an agressive 4 – 6 week deadline to get the businesses integrated

In the integration process, we are primarily focusing on the sales / product / pricing / go to market processes first – this will ensure that there is the least amount of confusion in the market.

Well there are some thoughts today … perhaps how we negotiated the deals tomorrow

Well i had one of those days last week.  I was working away and received an email from someone in another country asking to help us enter that country.  Normally i wouldn’t give it too much attention as we get these all the time however the person happened to be from my country and we nearby during the week.  I met with them and it was a perfect match – they know the market, have the contacts but not the expertise or funding and we have the rest.

90 min later we had an in principle agreement to seriously look at working together to enter the market.

So what makes a simple decision for a CEO in whether to seriously work with someone else?

For me it comes down to passion / entrepreneurship / clarity of thought and market knowledge.

The person i interviewed definitely has passion.  They approached us and could clearly demonstrate how we can enter the market and how they can make it happen for us (therefore less thinking for me).  The person has a clear history of entrepreneurship and they currently work for a future potential customer so they can deliver some of the sales that we need to get started.

So … the next time a penny falls from heaven — GRAB IT FAST with both hands as it doesn’t happen too often.