Thank you xxxxxx appreciate xxxxxxx for hosting me. My objectives this morning are to convince you of three things That there are a unique group of companies that have a hugely disproportional effect on the US Economy – and how they relate to the private equity market and to the issue of large corporate and US global competitiveness. That in order to survive and flourish that each of these companies have to complete a unique transition that in most cases is fatal to them called No Mans Land and is directly associated with the risk of investing in them from a private equity perspective. From an Entrepreneurial CEO’s perspective this is an overview of the transition issues faced by a company that have to be addressed in order for an emerging growth company to grow to scale and ultimately be endorsed by the capital markets. Many of us in the business of serving these companies also need to understand the issues that these companies face because if they are successful they become our best clients. That there are Four Navigational Rules that must be followed as a Map through the transition. They are immutable – like gravity. Leadership Notes Ask to talk about leadership No Mans Land Transition is a target rich environment that separates the really good leaders from those that are average Take this opportunity to talk to first about what we observed a Leader of a company that makes the transition has to do to be successful and then what leadership characteristic we can learn out of those observations.
Talk about No Mans Land- Where Growing Companies Fail and I want to start with the source of my original observations My Firm. Briefly describe the firm –started in business providing services to Entrepreneurial Growth Companies that’s Talk About the confirmation of my observations with those of my partners to describe this unique once on a life-time transition for emerging growth companies.
Lets start off with a picture that symbolizes some of the chaos going on in the economy. At the very bottom end of the scale you have start-ups and small companies. (1/10 start-ups fail) and contrary to most impressions they do not create most of the net new jobs in the US Economy Out of the caldron you have a second type of Company called a Gazelle the breaks out of the pack and grows very rapidly and approaches and enters a transition that I will talk about today – No Mans Land David Thompson did some outstanding research and documented his observations concerning a set of characteristics that companies that achieve a billion in revenue exhibit in his book Blueprint to A Billion. In the 7th page of his book he lays out a fundamental premise for his entire analysis with a graph. That graph depicts that companies that achieve a billion in revenue must navigate through an inflection point that averages $50 million in revenue. Dr. David Birch formerly of MIT single handedly pioneered the academic study of rapidly growing private sector firms and coined the widely used term “Gazelles” to describe them also notes a key inflection point at about 100 employees estimated to be between $10 and $20 million in revenue for private sector companies. Thompson’s data indicates that only 387 companies out of all of the companies that went public since 1980 (a 27 year period) made it to a billion in revenue. The target market for the No Mans Land material is not just for the 14 companies a year that will achieve a billion in revenue but rather for the 350,000 Gazelles identified in Dr. David Birch’s research that have grown at least 20% per year compounded over a four year period and the 35,000 companies that break out of that pack and become this country’s de facto research and development and the basis for the bulk of the middle market private equity deals done in the US. Following Issues get defined during the transition: Core Values Purpose and Mission BHAG “ Big Hairy Audicious Goal” – Does not have to be size related “ Small Giants” Strategic Anchors The Sandbox Value Proposition Brand Promise **** Refer to the speech at the Industrial research Institute
Our observations of the transition have lead us to conclude that we can explain the transition and the Navigational rules by analyzing the transition in the context of the 4M’s. The rest of the presentation is to describe the transition in each of these M’s and then offer a navigational rule that we believe is immutable , like gravity , must be dealt with if a company is going to survive the transition.
Start off with the Explanation of the Entrepreneur and the Gazelle Eco System: Quote from the Article published in the Industrial Research Institute Journal: Gazelles, by contrast, typically don’t understand who the ultimate customer is while developing and launching a product. They improvise as they go, making opportunistic promises to customers that in turn change the product and the company. Their business is a living laboratory; a process of discovering what ultimately is the right product, service and target customer. Early customers lead the gazelle to other customers, and the promises made to these new customers rarely size up with the existing delivery capabilities of the gazelle. Much of the innovation, then, occurs during the process of meeting the challenges of the promises made.
When the business is in its formative stages the entrepreneur is simultaneously executing the sales, marketing and operations aspects of the company. Mention the process of placing bets on the customer and the promises made that change the company. What happens is the physical limit of the leader is met.
Continue with the story of the Used Aircraft Parts Distributor, it’s the discussion about the sustainable value proposition. Story of Georges Music: chain of very profitable music stores, 5% of the retail music business in the US through a buying coop. Ultimately this brings up the issue of management Leadership Principle Its about the enterprise not the individual and the leader will make promises that stretch the enterprise and put it at risk. Issues for a Down turn Resist the temptation to buy sales Fire some customers Fire some products and services
This is singularly the single most emotional issue of the transitions, think about it – the folks surrounding the Entrepreneur include: People with him or her from the start Know there families Many were there when there was no hope
Story of Mikes Music, any number of cases that I have spoken to Story of the speech at Virginia Tech Story of Coon hunting – NY Not replacing themselves as CEO – used the aircraft parts mfg as an example Culture is used for failure on both sides: the issue of the inner circle and a trusted decision making process End of the letters page 77,79 Leadership Principle: Willing to have folks that will challenge them in the true inner circle and the ticket to entry is performance not personal loyalty. Down Economy Time for a (RIF) reduction in force Opportunity to steal your competitor’s best people
Side note to some of the policy issues that we face in this space the story of the new French technology Company.
Now we go to the Third M – The Economic Model
Lets Transition to a discussion the companies economic model Describe what an economic model is from the book “ When I speak of a business model, or as some call it, an economic model, I mean something quite specific: An analysis, in financial terms, of how a business makes money. Looking at an economic model means considering the capital deployed, the revenue produced by selling products or services to customers, and the changes in these elements of revenue, cost and capital under different scenarios.” Describe the software company preparing for Red Herring This slide depicts what most of these Gazelles represent to start with High Performance Cheap Labor and tas they grow they throw people at the proceeses which is why they add so many emploees. Tell the typical supervisor story : need more people
Show you a slide I use to illustrate the idea of an economic model based on using people. They don’t think in economic terms about their model and they hit a phenomenum during the transiton that can be quite dramatic.
Step Fixed costs: Effectively they must build out scalable infrastructure ahead of the revenue curve and understand why how and when they hit a profit zone: Let me give you an interesting example: Two of the cases in the book involve companies in the freight forwarding industry: Client private equity backed sold to Fedx, UPS got into the business They were lamenting what was going on in the business
Remarkable that both of these companies are just past $20 million. Data received from the Gazelle Institute data base, 2000 through 2005 -3 million business sample. Compiled from a variety of sources including US Census, IRS Corporate Source Book etc. From a private equity perspective, fascinating when you take into affect the assets required to get a company up into the 100 million plus range etc.
What a shame to enter into a transition without understanding how long the journey is. In some cases the only way to get there is with outside equity and acquisitions. Leadership Principle: The leader has a vision and a confidence in the economic future that he or she can clearly see and communicate. Down Economy Understand your business model Restructure your model around the new reality Create a daily report out of your command and control structure that lets you estimate your net income before the income statement is produced
The last M is a transition in the Money
Lets transition the to final M- the money M. An Illustration that I used in Congressional testimony regarding the unique issues faced by growing companies in the Dr. Ferguson Vice Chairman of the Fed had testified with me and had invited me to brief some of the economists at the fed tell them the story of Sam Norwood Sam Norwood and t-acounts
Capital Gap: transition form personal credit worthiness to depending on the business Quotes from a letter sent to a senior treasury official: Non-Regulated Asset-Based Lender The first interview was with a large non-regulated asset-based lender. This lender shared with us the results of a recently completed enterprise-wide customer profitability analysis. It included an analysis of the overall workload model, i.e., costs associated with Account Management and Collateral Management This analysis confirmed the decision by this particular lender to discontinue its national initiative to serve the market for asset-based loans below $1 million. The cost for this was broken down into three main categories, and included the following areas: (1) Loan acquisition costs (allocated cost of a seasoned loan officer or originator); (2) Asset monitoring costs (borrowing and reporting frequency workload); and (3) Risk adjusted cost of capital to the lender. The conclusion reached by the senior management of this enterprise was that it could not profitably provide capital to a business with asset-based lending needs below $1million at a rate below 25%. This $1 million threshold for capital associated with an overall cost to the borrower of less than 15% was also confirmed in a separate interview with a lending executive from another major non-regulated lender. One simple way to confirm our findings is to call on a random basis any number of non-regulated asset-based lenders and request information on their underwriting size and pricing models for asset-based loans. Super Regional Community Bank Holding Company The second interview was with a senior executive of a Super Regional Community Bank Holding Company. Again, this interview concentrated on the profitability analysis for smaller asset-based loans. The detailed information provided to us indicated the same types of cost constraints noted above for the non-regulated lenders. It should also be noted that this bank had migrated to funding asset-based loans at rates below 15% to companies that fit our definition as rapidly growing only if additional collateral from outside the business was pledged (i.e., real estate, certificates of deposit, etc.) of sufficient size and security to remove the need for constant asset monitoring by the bank. Even with this additional security reducing the cost of Collateral Management, we believe that if the true cost of Account Management were factored into the portfolio analysis these loans would at best be marginally profitable to the bank. Major Commercial Bank This interview confirmed the personal asset credit scoring methodology for small business loans and the Capital Gap that existed within this bank before any credit judgment methodology would be assigned to the loan request. This particular bank’s minimum loan threshold for assigning a credit officer was above our Capital Gap estimate of $1million.
Counter intuitive issue is that its all about risk not upside the complete opposite of how the entrepreneur looks at it. The key issue is getting the risks of the transition identified and controlled etc.
Always ask the CEOs to drive home thinking about the risk in the business and how they could get rid of it. Story of EMR and the New contracts Leadership Principle: Willing to publicly recognize and layout the real problems – the risks in the business. Economic Downtown Having and communicating early warning signals lowers the perception of risk Capital market particularly the banks supporting SMB hate surprises but will work with problems. Work to move your debt structure to higher cost lower covenant structures: make sure you have adequate liquidity. Liquidity is more important than the cost of capital in a down turn.