How Attractive Might Your Company Become?

We have spent many years building companies and counseling others to do the same. And we have come to recognize that growing a company is a natural extension of new venture creation. Entrepreneurship doesn't end with the creation of a venture. Indeed it is the growth and flour­ishing of a firm that fulfills the entrepreneurial promise.

The criterion used for assessing firm growth mirrors the opportu­nity screening process. However, there is a key difference. You have deep knowledge of the industry and the much-textured application of that knowledge. The problem lies in organizing that information and taking action based on your strategic vision!

The venture growth assessment framework (Exhibit 2.2) is not a "scorecard." Don't expect to tally a value at the end that will present a go/no-go decision. Rather, allow it to help you organize the intellectual capital owned within your firm and share it with trusted advisors and key partners. Once you have created the knowledge platform, act on it.

Assessing Your Deal

Opportunity Focus

"Screening" your company, or understanding if it has high value-creating potential, is a process that should not begin with strategy (which derives from the nature of the opportunity), nor with financial and spreadsheet analysis (which flow from the former), nor with estimations of how much the company is worth and who will own what shares.1

These starting points, and others, usually place the cart before the horse. Perhaps the best evidence of this phenomenon comes from the thousands of dot-com investments that turned sour in 2000, that were investor driven and not value focused. A good number of small business owners who try to grow run out of cash at a faster rate than they bring in customers and profitable sales.

Over the years, those with experience in business and in specific mar­ket areas have developed rules of thumb to guide them in screening opportunities. For example, during the initial stages of the irrational exuberance about the dot-com phenomenon, numbers of "clicks"

Exhibit 2.2 Venture Growth Assessment

Attractiveness

Criteria

Highest Potential

Lowest Potential

Industry and Market

Market

Customers User benefits Value added Product life

Market structure Market size Growth rate

Market capacity

Market share attainable (Year 5)

Cost structure

(continued)

Changes way people live and work

Market driven; identified; recurring

revenue niche

Reachable; we have long-term, loyal customers

Less than one-year payback

High; advance payments

Durable

Imperfect, fragmented competition or emerging industry

$100+ million to $1 billion

Growth at 30-50% or more in the last three years

At or near full capacity Under capacity

No identifiable leader

Low-cost provider; cost advantages

Incremental improvement only Unfocused; one-time revenue

Loyal to others or a struggle to reach More than three-year payback Low; minimal impact on market Perishable

Highly concentrated, mature, or declining industry

Unknown, less than $20 million or multibillion

Contracting or less than 10% growth over the last three years (and we're not getting our share)

Need for company growth

Plenty of companies looking for new business

Less than 5%

Declining cost. . . this is becoming a commodity

Exhibit 2.2 Venture Growth Assessment (continued)

Criteria

Highest Potential

Lowest Potential

Economics

Breakeven/positive cash flow

ROI potential Capital requirement

Internal rate of return potential

Free cash flow characteristics: Sales growth Asset intensity Spontaneous working capital R&D/capital expenditures Gross margins After-tax profits

Break-even profit and loss

Harvest Issues

Value-added potential

Valuation multiples and comparables

Consistent free cash flow

25% or more per year Low to moderate; fundable

25% or more per year

Favorable; sustainable; 20-30% or more of sales

Moderate to high: +1 5% to +20%

Low/sales $

Low, incremental requirements

Low requirements

Exceeding 40%; durable

High; greater than I 0%; durable

Breakeven not creeping up

High strategic value

Price/earnings = 20 + xs; 8-1 0 + x(, EBIT 1.5-2 + x,, revenue: free cash flow 8-10 + x.

Highly cyclical with years of positive and years of negative cash flow

Less than 10%

Very high; always struggling to fund or can't find funding

Less than 15% per year

Less than 10% of sales Less than 10% High/sales $ High requirements High requirements Under 20% or declining Low; 0-10%, and unstable

Breakeven creeping up

Low strategic value

Price/earnings ^5x, EBIT ^3-4x; revenue^.4

Exit mechanism and strategy Capital market content

Competitive Advantage Issues

Fixed and variable costs

Control over costs, prices, and distribution

Barriers to entry:

Proprietary protection Response/lead time Legal, contractual advantage Contracts and networks Key people

Management Team

Entrepreneurial team

Industry and technical experience

Integrity

Intellectual honesty

Personal Criteria

Goals and fit

Upside/downside issues (continued)

I can name the companies that should buy us.

Favorable valuations, timing, capital available; realizable liquidity

Lowest; high operating leverage Moderate to strong

Have or can gain Competition slow or napping Proprietary or exclusivity Wei I-developed; reliable Top talent an A team

All-star combination; free agents Top of the field; super track record Highest reputation Know what they do not know

Getting what you want; but wanting what you get

Attainable success/limited risks

Undefined; illiquid investment Unfavorable; credit crunch

Highest Weak

None

>
Unable to gain edge <£

None £

Crude; limited, unreliable > -

2
B or C team o

*! O C •p Weak or solo entrepreneur

Underdeveloped ^

Questionable or unknown/unrecognized >

Do not want to know what they do -

not know ^

O H m

2

Surprises, as in The Crying Game ^

> r-

Linear; on same continuum

Exhibit 2.2 Venture Growth Assessment (continued)

Criteria

Highest Potential

Lowest Potential

Opportunity costs Desirability Risk/reward tolerance Stress tolerance

Strategic Differentiation

Degree of fit

Team

Service management

Timing

Technology

Flexibility

Opportunity orientation

Pricing

Distribution channels

Room for error

Acceptable cuts in salary, etc. Fits with lifestyle and belief system Calculated risk; low risk/reward ratio Thrives under pressure

High

Best in class; excellent free agents

Superior service concept

Rowing with the tide

Groundbreaking; one of a kind

Able to adapt; commit and decommit quickly

Proven experience in exploiting opportunities

At or near leader Accessible; networks in place Forgiving strategy

Comfortable with status quo Simply pursuing big money Risk averse or gambler Cracks under pressure

Low

B team; no free agents

Perceived as unimportant

Rowing against the tide

Many substitutes or competitors

Slow; stubborn

Operating in a vacuum; napping; hasn't made significant changes in years

Undercut competitor; low prices

Unknown; inaccessible

Unforgiving; rigid strategy

changed to attracting "eyeballs," which changed to page views. Many investors got caught up in "false" metrics. Those who survived the NASDAQ crash of 2000-2001 understood that dot-com survivors would be the ones who executed transactions. Numbers of customers, amounts of individual transactions, and repeat transactions became the recognized standard.2 What are the key drivers in your industry?