As I write this note, we are all facing uncertainty and working hard to determine how the current pandemic will impact our economy. I am not a medical professional so I will not comment on the health aspects of this situation, but I do believe there are three points we must consider as we attempt to manage our portfolio for the future:
1. This is serious
We must plan, prepare, and execute. We must address the situation as it evolves and be ready to respond because things are changing quickly, so we also must move fast to manage those changes. We are working with our portfolio companies to consider all options with employees, vendors, and capital sources. No matter what, we should understand the gravity of the moment so that we do not miss out on any opportunities that arise, such as the recent CARES act, to help our businesses prepare to grow again in the future.
2. This time is different
Thinking back to 2008, we all remember that Monday morning collapse of Lehman Brothers. The resulting recession was painful and led to many layoffs like we are seeing now, but we must remember that by the fall of 2008 asset values had been sliding for many months prior to the final shock, so the market was already on shaky ground and was not able to withstand the impact. Prior to the current pandemic, by contrast, overall markets and indicators were strong, with high stock values and very low unemployment. We cannot know how this will play out, but we must recognize that this market environment is fundamentally different from 2008, and thus businesses with strong fundamentals will be valuable as the economy reopens.
3. There is opportunity in crisis
I am not suggesting any of us take advantage of the pain others may be experiencing right now, but we are currently considering certain opportunities to invest in industries we already had been researching. There are good business models that will succeed as demand returns, and for these possibilities we should be investing into the downturn so we can prepare for the rebound while many others are standing still. We will continue to find and partner with good businesses now so we can together capture share once things start growing again.
There is much uncertainty enveloping us today and the world outside our windows today seems much more still than it did only a few weeks ago. Regardless we must resolve to move forward, and we at Pareto are using these brief points to help guide our path forward as we all work to embrace our communities together.
Stay safe everyone and thank you.
In this month’s blog, we talk with Founder and CEO of Bridge Financial Technology, Rasheed Hammouda, and ask him a few questions about fundraising for his company.
Question #1: How do you start the process of fundraising?
I know as an early-stage founder, I didn’t think about it a lot. I mainly just started doing it, which seems to be the case in the startup world. As a result of that, the first time we went to the market to raise funds we were unsuccessful and started bootstrapping. During our second, more calculated attempt, we had a little bit of success. Our most successful attempt at fundraising was our first official round last November. It was a more thought out and detailed process. We began identifying funds in advance and staggering our outreach to those funds. You can't put all of your eggs in the first basket, because you will refine your pitch and get better over time. This creates the ability to create urgency with each new batch of funds you start talking to.
The most important thing is knowing you need to raise money. Running out of money is certainly the most urgent situation in needing to raise funds, but you don't want to seem desperate. You need to identify what the money is going to be used for and what kind of company you are going to be. This can be difficult in the beginning, but you need to create a realistic time horizon that will align with investment outcomes of the funds. Some funds are only interested in companies with billion dollar outcomes, while some are more interested in safe bets with lower exits. Those outcomes are very different investment profiles. You need to rid your pitch of misalignment with the investors.
Question #2: How do you think about finding the ideal capital source and how has that changed over your different rounds of fundraising?
They say finding an investor is like getting married, and you really want to make sure that there is a match in as many areas as you can. You need to know what is important for your business at a given time. For us, early on, we were focused on old school outbound sales techniques and finding an investor who understood our customer acquisition model was very important. If we are talking to an investor who only does marketing and channel partnerships, our goals wouldn't have aligned with them. There is no better substitute to your own sales team. There are things that can add to and compliment it, but it's hard to replace your own team. Now in our company, it's about going from a small and lean team to a larger team. You now have to deal with scaling challenges. Things have changed over time since we launched Bridge. For instance, having the option for a venture debt piece in our fundraising wouldn't have been an option when we started. Right now is a good time to start companies. Especially if you are in capital heavy areas.
Question #3: Do you think it makes it harder or easier to close, given the proliferation of capital sources in the industry?
The number one thing that will help you close a deal fast is having a company that people want to invest in. It sounds so obvious, but for founders there is a lot of pressure to be visible. I do think those trends are starting to slow down. For some traditional VC funds the “pray and spray” approach can be successful if you have a defined process, but investors are starting to look under the hood a little bit more. It’s making those with capital more selective. Finding investors that can get on board with our focus in building a better company and not being afraid to spend a little money is key. I think a lot of founders get hung up on valuation, but the deal structure is so much more important. There are other ways to get levered if you’re not careful. Having a nice term sheet is much more advantageous. You have to think, what does the fund want to see over a time horizon and what type of company do we need to make that happen. If you have an explosive growth company you can set whatever terms you want. However, most companies don't look like that because you are trying to figure out very important parts of the business. You need some humility around what your business looks like.
To learn more about Bridge Financial Technology, visit their website at www.bridgeft.com.
Although it may seem complicated, pursuing a roll up or consolidation strategy may be a great way to grow a business. In the blog today we will answer a few of the most popular questions that people ask about business rollups and acquisitive growth.
Question #1: What are the primary economic considerations that separate acquisitive growth from organic growth?
When you are looking at a business you need to be able to decide how best to quickly develop sales. As much as private equity traditionally focuses on EBITDA and cost cutting, sales are the key driver for organic growth and can even help solve the same problems. Often times you may have a business with a large amount of fixed costs, so when you increase sales, those fixed costs become a smaller percentage of your revenues and you improve your margin overall. One key method of increasing sales is by acquiring those new revenues, which would be the primary argument for an acquisitive approach.
Question #2: How do you manage the pitfalls that could be associated with acquisitions? For instance, company culture or employee issues?
Simply put, it is not easy. When you are taking multiple companies and smashing them together, you are bound to have some challenges. A lot of times people have been operating based on their preconceived notions or the “old way” of doing things - sometimes this may be the right answer, but not always. In some cases, organizations have operated with their heads in the sand and therefore are resistant to change. The best ways to get over that are to first, be honest and open with your employees; second, review all roles and employees to ensure that each individual is in the role that best utilizes their skills. Doing so may mean some employees transition out, but often it simply means that an individual would better suit the company if they changed roles. Taking an objective approach to these changes is key to help ensure buy in from all the employees to make for a smoother transition.
Question #3: What strategies can be used to better be prepared for the integration stage of the rollup cycle?
Perhaps the best thing that you can do is prepare, prepare, prepare. This is something that cannot be said loudly enough. Rolling up companies and mixing company cultures is often messy. Doing as much preparation in advance as possible cannot be understated. For instance, working with insurance agents to combine insurance policies, or working with a PEO to ensure that new employees are correctly on-boarded. These things take a long time and scheduling ahead will make the post-closing period much easier.
Question #4: When pursuing a rollup or consolidation strategy, how do you approach financial considerations? For instance, funding for further acquisitions.
Certainly one of the biggest considerations in this type of strategy is ensuring you have enough capital to execute the next few acquisitions. You need to make sure that you have enough capital in place to fund the initial closings as well as a plan for funding future opportunities even if you don’t have a clear pipeline just yet. It is important to have a cushion or sources that are easily accessible to execute on future transactions because sometimes you have to move quickly. You also need to take into consideration the costs to scale your growth and, if you are doing so via organic growth, you must consider total costs of sales trips and marketing expenses instead of purchase prices. Either way, ensure you have a runway to fund your growth and move as fast as your lucky breaks will allow.
Question #5: What tips could you provide for when knowing a rollup is the right strategy?
The answer is the same as it relates to both acquisitive growth and organic growth. Align your growth strategy with the product or service your company is offering. If you can grow quickly simply by putting more sales people to work, organic growth may be the most cost effective approach versus spending capital on new acquisitions. On the flip side, if your industry faces a much longer sales cycle, buying new accounts and revenues could move the needle more quickly and would thus argue for an acquisitive approach. Either way, base your decision on what will impact the numbers most quickly and show the most upside.
Why talk about economics in a blog focused on investing? Because the core of any good business is economics. This brings up the question that is our focus today: how can a business leverage economics to make a case to its investors?
Every business at its core has to solve one of the two sides of a central economic tenant, the cost benefit model. This may mean reducing the cost or enhancing the benefits for a buyer. This tells us that a buyer will only take action if, and only if, the additional benefits outweigh the associated costs. This needs to be articulated to investors by letting them know exactly what your product solves for. Make sure they understand not only what you are selling, but also understand the costs as well. And remember to include both those implicit and explicit costs so that investors, or the buyers themselves, understand the full opportunity cost of your product or service. Put the dots very close together - tell investors what this product is going to do, its opportunity cost, and which side of the cost benefit equation you are solving for.
You also must clearly define the market for your idea. No matter what type of product or service you have, a target market has to be defined. Conceptually, there has to be at least one person who is willing to purchase your product before you have a market for your product at all. You must convince the investor that there is not only a market, but that you have identified the correct market and that said market is sufficiently large, easily accessible, or both. Identifying the market does not mean you will be instantly successful, but there is no way to be successful without identifying a market in the first place.
This goes back to the basics of supply and demand and the perceived identification of equilibrium. This is the point at which there are just as many buyers as sellers and everything is “just right.” You must be able to identify how both supply and demand work for your product in order to understand what that equilibrium price “should” be. You may choose to price above or below that price, but understanding where it most likely exists will help you determine if your current model can be profitable and sustainable. Showing an investor that you understand these concepts is critical to prove that you did the homework before making your pricing decisions and will further help articulate how you defined your market.
In conclusion, study some economics and do your homework, because every potential investor needs to see that you understand the basics. Pick up a number two pencil, sharpen it and show investors the numbers. This will display and understanding of economics and make it more likely that an investor believes you when you say your business can succeed.
To hear more on this topic please listen and subscribe to our podcast, “The Pareto Perspective,” and also follow us on social media for updates.
Balanced investing could have multiple interpretations, but what does it actually mean? For us as investors we believe a balance between the goals of business owner and private capital source generates the best returns for each. How do we put this balance into our investments? Focusing on five critical areas helps lead our decision making and operational enhancements:
1. Sharing Expertise
Every business must have a smart operator who understands what skills are needed for success in their industry. And that smart leader must continue contributing their expertise to the business even after they have sold, rolled some equity, or taken on a new financial partner. At the same time, the new private capital source must also add value. The business can leverage their experience around building a board, managing an acquisitions pipeline, our forming a sales organization. A “dumb” check helps nobody. To find success, leverage the expertise from both management and investors to scale.
2. Maintaining an External Eye
Business owners often get bogged down by all the daily tasks for their business. It is challenging to be objective and think about strategy or ask tough finance questions when you are on the phone with customers or installing new technology. A good private capital partner will add value by looking at the current state with a fresh and external eye. They now have a role to play as part of the team and, as Jim Collins wrote, “get the right people on the bus, the right people in the right seats,” and leverage their outside perspective.
3. Fostering a Healthy Debate
Owners and investors both need to value the idea of continually raising questions, and sometimes asking very hard questions. Things an investor has done in the past may not work for every deal, but they should question things that differ from their experience. Owners should avoid being complacent and similarly question every process even if the correct answer is to maintain the current approach. Do not be afraid to foster a culture of debate with a goal of finding the best answer based on the data, rather than deciding who is wrong or right.
4. Aligning Incentives
Everyone involved in a transaction needs to be focused on achieving a positive future outcome. Whether that takes the form of an exit, recapitalization, or continued growth, the dream of a “big check” should be meaningful to both business leader and capital provider. The most success we have seen comes when the founder, investment team, and other key management team members all have skin in the game either via direct equity ownership or other incentive structures. Doing this creates a bigger pie for everyone, and tying individual payoffs to the combined company growth means everyone works toward the same goals.
5. Crafting a Shared Vision
A good future outcome is highly unlikely if the investors are targeting a different type of exit or time horizon than the CEO and management team. Going in separate directions will lead to confused reporting, bad hiring decisions, or contentious board meetings. To be successful you must have a shared vision that is crafted by all parties. Everyone must jointly decide how to get from today to where the business wants to go, and then continue to reevaluate as the company makes progress. Avoiding this will stifle growth and could ultimately damage the partnership.
Each of these five areas must be considered to truly balance the investment and partnership goals between business owner and private capital provider. Balanced investing can be achieved so long as everyone involved gets on the same bus heading towards future success.
To hear more on this topic please listen and subscribe to our podcast, “The Pareto Perspective,” and also follow us on social media for updates.