The principal cause of early stage business failure is the lack of adequate capital, both working capital and permanent capital. The CFO has the responsibility to assess the capital needs of the business and fill those needs.
The projections or Financial Model, described earlier provide the basis for determining the aggregate capital needs of the enterprise. The CFO then selects the quote "best" blend, type and sources of financing.
The types of financing to be considered include short-term debt, long-term debt, leasing or other off-balance sheet financing and various forms of equity. Potential financing sources to be considered include bank, commercial finance companies, individuals, private equity groups, organized venture funds and the public market.
The blend or mix of capital chosen must balance the cost of capital and risk. For example, debt is less expensive than equity in terms of both interest caused an equity dilution. However equity holders do not demand monthly interest payments and they are repaid only upon sale of liquidation of the business. Therefore equity is less risky to the business than debt.
The CFO has the responsibility to develop the required documentation (generally referred to as the "book"), identify the potential sources, conduct the negotiations and close the deals.
The CFO also has the responsibility to manage relationships with capital providers and their representatives. This group includes bank credit and loan officers, investment bankers, stockholders and, if the company is publicly traded, stock analysts and regulatory agencies.
The most critical providers of capital to the business, the trade creditors, should not be ignored by the CFO. We will have more to say on that topic in a future post.
Friday, February 12, 2010
Efficient use of capital
Capital, both debt and equity, is expensive. A company must husband this precious resource and constantly monitor its use.
The CFO has the responsibility to optimize the use of capital. Working with the Controller, the CFO must assure that the appropriate information is captures and reported in a meaningful fashion.
In a retrospective fashion, the CFO is responsible for measuring the historical use of capital within the organization. This task is accomplished through a careful monitoring of the allocation of capital to each business activity. Techniques such as the analysis of net capital employed by each product group or function and economic value analysis may be used.
From a prospective view, the CFO establishes guidelines and procedures to assure efficient use of capital. This includes establishment and monitoring of capital expenditures and other commitment of capital, such as leases. Generally, any long-term commitment of resources is subject to review and analysis by the CFO.
The next post will deal with managing the right hand side of the balance sheet.
The CFO has the responsibility to optimize the use of capital. Working with the Controller, the CFO must assure that the appropriate information is captures and reported in a meaningful fashion.
In a retrospective fashion, the CFO is responsible for measuring the historical use of capital within the organization. This task is accomplished through a careful monitoring of the allocation of capital to each business activity. Techniques such as the analysis of net capital employed by each product group or function and economic value analysis may be used.
From a prospective view, the CFO establishes guidelines and procedures to assure efficient use of capital. This includes establishment and monitoring of capital expenditures and other commitment of capital, such as leases. Generally, any long-term commitment of resources is subject to review and analysis by the CFO.
The next post will deal with managing the right hand side of the balance sheet.
Analysis for decision-making
The most important contribution the CFO can make to an emerging growth company is providing the analytical framework for the management of the business-the “business model". The creation of this model involves a business analysis of past and future operations.
First required is a clear understanding of the business processes (design, development, production, sales, distribution, etc.) as well as an understanding of the nature of the business relationships with customers and suppliers. The CFO also must understand the business owner's goals, objectives and timetable. Finally, the CFO must have a good grasp of the economic environment and the near-term and longer-term outlook.
Historical operations must be evaluated, particularly to understand the prime drivers for revenue and expenses. Techniques used might include direct costing activity based costing.
The end result of this analysis should be an articulation of the enterprises’ “business model”. This model is a set of statements describe how the business creates and serves its customers. It also describes how the enterprise differentiates itself from the competition.
This understanding is then translated into a detailed, flexible income, cash flow, and balance sheet forecast. This "financial model" becomes the most valuable tool the company has for the evaluation of a variety of business decisions.
This model allows a continuous review of the company's pricing policies to assure that the pricing is value driven, reflecting all appropriate costs and consistent with the short-term and long-term goals of the company.
This model also permits evaluation of comparative data for competitive benchmark analysis of current and future performance. This information is compared to that developed through an evaluation of the industry competitors companies in similar industries as successful business enterprises in general area
Most importantly, using this analytical framework the CFO is able to provide the board and senior management with an evaluation of the financial impact of various strategic options. These include new facility decisions, new product line or business activities and acquisitions or divestitures. As a result of the insight gained by the CFO through this process, typically it is appropriate for the CFO to have principal responsibility for the structuring and negotiation of major transactions.
Next time we'll take a look at the CFO's responsibility for the efficient use of capital.
First required is a clear understanding of the business processes (design, development, production, sales, distribution, etc.) as well as an understanding of the nature of the business relationships with customers and suppliers. The CFO also must understand the business owner's goals, objectives and timetable. Finally, the CFO must have a good grasp of the economic environment and the near-term and longer-term outlook.
Historical operations must be evaluated, particularly to understand the prime drivers for revenue and expenses. Techniques used might include direct costing activity based costing.
The end result of this analysis should be an articulation of the enterprises’ “business model”. This model is a set of statements describe how the business creates and serves its customers. It also describes how the enterprise differentiates itself from the competition.
This understanding is then translated into a detailed, flexible income, cash flow, and balance sheet forecast. This "financial model" becomes the most valuable tool the company has for the evaluation of a variety of business decisions.
This model allows a continuous review of the company's pricing policies to assure that the pricing is value driven, reflecting all appropriate costs and consistent with the short-term and long-term goals of the company.
This model also permits evaluation of comparative data for competitive benchmark analysis of current and future performance. This information is compared to that developed through an evaluation of the industry competitors companies in similar industries as successful business enterprises in general area
Most importantly, using this analytical framework the CFO is able to provide the board and senior management with an evaluation of the financial impact of various strategic options. These include new facility decisions, new product line or business activities and acquisitions or divestitures. As a result of the insight gained by the CFO through this process, typically it is appropriate for the CFO to have principal responsibility for the structuring and negotiation of major transactions.
Next time we'll take a look at the CFO's responsibility for the efficient use of capital.
The unique role of the CFO
A critical team member for the success of an emerging growth company is the chief financial officer. However, in many early stage companies, the rolling contribution of the CFO is not clearly understood and this missing function is frequently a major factor in the Enterprises under performance or failure.
Most entrepreneurs understand the necessity and contribution of the controller and frequently confuse it with the CFO's role. However, the roles are very different.
The role of the controller is reporting and control. This involves the design and monitoring of systems for the recording of transactions entered into by the company. These transactions are then summarized into standardized accounting and tax reports.
The role of the chief financial officer, however, is that of the business/financial advisor to the CEO, the Board of Directors and the members of the senior management team. As such, the CFO has three principal duties:
1. Providing the analytical framework for the management of the business.
2. Assuring the efficient use of capital within the organization.
3. Managing the right-hand side of the balance sheet.
Frequently, emerging growth companies have limited resources and limited or temporary need for these services. This limited or temporary requirement may be driven by a need for additional capital, acquisition, disposition or expansion opportunity or from the strain of rapid growth.
This reality has created a market need for professional CFOs who offer their services on a part-time basis. This need is being satisfied by retired financial executives as well as full-time practitioners. Such professionals can offer the skill level of sophistication needed by the enterprise.
We will discuss each of the key CFO responsibilities in subsequent posts.
Most entrepreneurs understand the necessity and contribution of the controller and frequently confuse it with the CFO's role. However, the roles are very different.
The role of the controller is reporting and control. This involves the design and monitoring of systems for the recording of transactions entered into by the company. These transactions are then summarized into standardized accounting and tax reports.
The role of the chief financial officer, however, is that of the business/financial advisor to the CEO, the Board of Directors and the members of the senior management team. As such, the CFO has three principal duties:
1. Providing the analytical framework for the management of the business.
2. Assuring the efficient use of capital within the organization.
3. Managing the right-hand side of the balance sheet.
Frequently, emerging growth companies have limited resources and limited or temporary need for these services. This limited or temporary requirement may be driven by a need for additional capital, acquisition, disposition or expansion opportunity or from the strain of rapid growth.
This reality has created a market need for professional CFOs who offer their services on a part-time basis. This need is being satisfied by retired financial executives as well as full-time practitioners. Such professionals can offer the skill level of sophistication needed by the enterprise.
We will discuss each of the key CFO responsibilities in subsequent posts.
Wednesday, January 20, 2010
Why sell your business?
After years of building enterprise value an entrepreneur is forced to decide if and when they should realize on the value they have created.
Sometimes a buyer just appears and offers more than a business is worth. However, just in case no one shows up with a wheelbarrow full of cash you'd better have a plan for a sale.
To develop the most appropriate action plan for a sale, the owners of the business should first identify the true motivation for desiring a sale. They should also identify the motivation they will present to potential buyers, which might be very different.
The rationale for a sale, usually presented to buyers, includes the following:
· Lack of next-generation family members in management is a common problem. Interests and lifestyles, in a second-generation, are different.
· Estate planning, or rather, the need for cash to pay estate taxes.
· Cash may be needed for other purposes. These might include a charitable gift, investment in other activities and the like.
· The requirement for capital or other resources to scale or reach critical mass in order to seize a market opportunity.
· Closely related is the opportunity to dramatically impact the cost structure through consolidation of functions or facilities.
The last two, which are key “inflection points” in the life of the business, are the “best” reasons for a sale.
However, many companies offered for sale are driven by more troublesome reasons.
· Fear of the future. The buying habits of a major customer may change, technology continually evolves or actions by a major or new competitor may seriously disrupt the market.
· Inability to continue as an independent company. Bank lines may be expiring, bonding might be unavailable, working capital needs may have become unachievable and the like.
· As for value accumulates, owners become more risk adverse and may seek liquidity to protect years of work.
· The management team is tired and worn out.
The real reason for a sale should drive the timing and methodology for buyer identification selected by the entrepreneur.
We will look at alternatives to a sale in a future post.
Sometimes a buyer just appears and offers more than a business is worth. However, just in case no one shows up with a wheelbarrow full of cash you'd better have a plan for a sale.
To develop the most appropriate action plan for a sale, the owners of the business should first identify the true motivation for desiring a sale. They should also identify the motivation they will present to potential buyers, which might be very different.
The rationale for a sale, usually presented to buyers, includes the following:
· Lack of next-generation family members in management is a common problem. Interests and lifestyles, in a second-generation, are different.
· Estate planning, or rather, the need for cash to pay estate taxes.
· Cash may be needed for other purposes. These might include a charitable gift, investment in other activities and the like.
· The requirement for capital or other resources to scale or reach critical mass in order to seize a market opportunity.
· Closely related is the opportunity to dramatically impact the cost structure through consolidation of functions or facilities.
The last two, which are key “inflection points” in the life of the business, are the “best” reasons for a sale.
However, many companies offered for sale are driven by more troublesome reasons.
· Fear of the future. The buying habits of a major customer may change, technology continually evolves or actions by a major or new competitor may seriously disrupt the market.
· Inability to continue as an independent company. Bank lines may be expiring, bonding might be unavailable, working capital needs may have become unachievable and the like.
· As for value accumulates, owners become more risk adverse and may seek liquidity to protect years of work.
· The management team is tired and worn out.
The real reason for a sale should drive the timing and methodology for buyer identification selected by the entrepreneur.
We will look at alternatives to a sale in a future post.
Tuesday, January 12, 2010
Before you sell
Each year thousands of middle market companies are sold to other entrepreneurs, corporate buyers or buyout firms as they face succession and estate planning issues.
For most owners of privately held middle market companies selling a company is a once-in-a-lifetime event. Frequently, these owners do not fully recognize the value creating elements within a business enterprise. As a result, many of these companies will be sold for less than their potential value.
The valuation of a business is a complex issue. Scores of different factors influence the final value. However, I believe there are five key steps the owners of a privately held business can and take to dramatically improve the value of an enterprise in an eventual sale.
From the first days of start-up until the closing of a sale, the five key steps remain the same. These steps are:
1. Develop a defensible market position
2. Build a management team
3. Reallocate resources to the best use
4. Improve the skills and quality of the work force
5. Eliminate all contingencies
Each of these steps and related issues will be discussed in future posts.
For most owners of privately held middle market companies selling a company is a once-in-a-lifetime event. Frequently, these owners do not fully recognize the value creating elements within a business enterprise. As a result, many of these companies will be sold for less than their potential value.
The valuation of a business is a complex issue. Scores of different factors influence the final value. However, I believe there are five key steps the owners of a privately held business can and take to dramatically improve the value of an enterprise in an eventual sale.
From the first days of start-up until the closing of a sale, the five key steps remain the same. These steps are:
1. Develop a defensible market position
2. Build a management team
3. Reallocate resources to the best use
4. Improve the skills and quality of the work force
5. Eliminate all contingencies
Each of these steps and related issues will be discussed in future posts.
The purpose of this blog
Thank you for visiting the blog for Palladino Associates, written by Tony Palladino. Palladino Associates is a consulting firm dedicated to helping entrepreneurs and private equity owners, build and realize upon enterprise value.
The purpose of this blog is to discuss topics that entrepreneurs need to focus on, as they move from start up to sale of the business enterprise. The concept and suggestions discussed in this blog are directed to the environment in which these entrepreneurs typically work. These posts deal with business enterprises from the early start up days to the building of a mature and successful business enterprise.
Depending upon the nature of the business and the industry it serves, this maturity typically occurs at sales between $5 and $50 million. Many of the concepts discussed in this blog are applicable to any size enterprise at any stage of its development. However, a key assumption in most of these discussions is that the companies are privately held and not subject to public reporting considerations.
I welcome your comments and thoughts.
The purpose of this blog is to discuss topics that entrepreneurs need to focus on, as they move from start up to sale of the business enterprise. The concept and suggestions discussed in this blog are directed to the environment in which these entrepreneurs typically work. These posts deal with business enterprises from the early start up days to the building of a mature and successful business enterprise.
Depending upon the nature of the business and the industry it serves, this maturity typically occurs at sales between $5 and $50 million. Many of the concepts discussed in this blog are applicable to any size enterprise at any stage of its development. However, a key assumption in most of these discussions is that the companies are privately held and not subject to public reporting considerations.
I welcome your comments and thoughts.
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