So now after a couple of months, now that the reality has set in, I’m here to report on the remaining lustre of the dream.

There’s no denying that life is challenging now. For starters, I’m working more hours in a week than I previously worked in a month. And for all this work, I now have no regular income. The work is much more difficult and varied too. I thought life as a private equiteer was varied, but startup work is coal-face work; there’s no advising from afar. You design, implement, execute and improve, everything yourself.

With all of that said, I wouldn’t change it for the world. And that’s because it’s the ultimate challenge.

I’m now working in an office with a group of other enthusiastic entrepreneurs. And the air is electric. Everyone wants to be here. They’re giving their businesses everything. They’re passionate. They’re talkative. They have ups; they have downs. But they all keep moving forward at such amazing pace that it becomes self-propigating, creating a whirlwind of activity.

I learnt a lot from private equity and I enjoyed my time in what seems the perfect career. But startups are like cage fighting; they’re primeval and they reach to our roots. Maybe if I had the genetic composition, I’d have chosen cage fighting instead.

Back in the ol’ days, it took a lot of effort to get enough food to maintain health. You had to chase animals, kill them, skin them, cook them, etc. Now, you just dial Dominos and can over-eat to your heart’s discontent. So ironically, rather than chase animals to keep healthy (which is very hard work), we just have to stop putting nasty food into our mouths (relatively easy). Sounds crazy in the context of Sub-Saharan Africans dying from starvation. But I digress. Success in business is very similar; it’s more psychological than physical or skillful.

So here it is, the #1 ingredient to success in business is … Hustle, which generally means being resourceful and uninhibited in going after what your business needs most. Not what you’re willing to do most, but what the business needs most (big difference). I know what you’re thinking, “I already do that.” Well, I bet you don’t. But don’t worry, neither do I. And since admission is the first step to recovery, we’re making good progress. Consider the following to demonstrate this concept:

• Make a list of the things your business would most benefit from
• Forget convention, forget inhibitions, even forget morals, laws and ethics (for a moment)
• Items may include, contact Steve Jobs, get PR via popular TV show, paint your company name onto the side of Air Force One, call the CEOs of all your competitors, call your top 100 customers, run naked through the streets handing out PR material, etc.
• Items shouldn’t include, update CRM, do SEO, lodge my tax return, post on blog every day, make a couple of sales calls, etc., they MUST be things that will add MASSIVE value to your business (e.g. Gary Vaynerchuk getting onto Conan O’Brien)
• Don’t ponder the items, just write them down before you find reasons not to add them; forget reasons, just think “value”
• Now, look at the list, consider each item and watch yourself rationalise not following through

If you “had your hustle on”, you’d do most of the items. If you don’t have your hustle on, you’ll make excuses. ”Oh, Steve Jobs won’t answer my email. That TV show won’t have me on. I’ll do that task tomorrow. I’ll be arrested and charged with treason. Etc.” If you had your hustle on, you’d think, “there is no tomorrow, there’s only right now!”

Of course you shouldn’t do anything too illegal, but err on the side of taking chances (certain jails are way too horrific to teach you any worthwhile lessons). And before you get all holy-than-thou on me, remember it can be illegal (in some places) to put up posters, market to the public, run around naked, and even search the web using Google. But I very much doubt people will go too crazy; the real risk is in being too mediocre.

I guarantee if every day you made that list and did everything on it (that didn’t lead to a Colombian jail), you’d be many times more successful. Just like keeping fit and healthy, success in business doesn’t depend on skill, it depends on excuses (or lack thereof). What do you think? Am I talking nonsense?

Think about the big tech companies such as Google, Microsoft, Cisco and Apple. If you ask what these businesses are about, you’ll get closer to the root of essence.

I’m stepping a little out of my circle of competence here, but I’d say Google’s essence is providing a nurturing environment for employees that supports unfettered research and development. I’m sure they’ll gush some company line about being customer focused or shareholder focused or focused on whomever is asking. But I think the essence of Google is more about its employees than anyone else.

I think Apple’s essence is about design innovation and product differentiation. Again, they may argue they’re customer focused (tough to argue after their recent silence on issues with the iMac), but the truth is plain as day. We don’t really hear about Apple’s employees the way we hear about their rock star counterparts at Google. We don’t even hear about Apple’s newest, most revolutionary technology. But we do hear about design, about simplicity, and about differentiation.

Okay, this is all a little wishy-washy, but it became apparent when we recently tried to hire people for a new investee. There was talk of “culture” and how the new person had to be easy going, easily approachable, and not too aggressive. But that wasn’t the essence of this particular company. We could hire innumerable easy going people, but would they relay “the message”?

It’s worth asking what you’d like the essence of your new/existing company to be. Compare that to what it really is and ask why. As we can see with Google, Apple, et al., essence drives businesses beyond facts and figures. Most private equiteers would cringe at such nonsense, but then most aren’t advocates of long-term value creation either.

Image: Essence is more than corporate culture [source: Shutterstock]

What does it mean to work at capacity?

Capability and capacity relate to more than just potential physical energy. For example, I could apply 100% of my physical energy to lifting tiles onto a roof, and by day’s end, move 500 of them. Or, I could use 10% of my mental energy and 10% of my physical energy to move 5000 tiles by hiring a conveyor belt (hypothetically speaking). The combination of mental and physical energy can move mountains.

How productive do you think you are?

I find that people are rarely honest with themselves about this question. Ask yourself how productive you are (in percentage terms of mental and physical capacity on an average day) and then ask yourself again. Remember, at 100% capacity you’ll be moving figurative mountains. So, imagine the mountain you’re capable of moving and compare that to how productive you think you are. Then, once you know you’re being honest with yourself, compare that to the productivity of your team and your expectations of your team.

How does salary affect workplace productivity and output?

In my last post, I lamented that managers don’t realise how unproductive underpaid people can be. However, this is only an issue when employees aren’t fully engaged (and inspired and challenged and appreciated). The problem is, I think most employees feel somewhat disengaged most of the time. So, when they cross a certain level of disengagement (even if only for a day), salary becomes an issue very quickly. Then once it does come up, it generally remains an issue until rectified.

My suggestion isn’t to grant six-figure bonuses; I think you can get much more value from being genuinely fair. Keep an eye on market rates and adjust your employees’ salaries without them having to ask. The average employee doesn’t expect you to be proactive with pay rises, so this token gesture can actually make a tangible difference to productivity, loyalty and even engagement.

But, what does that really have to do with productivity?

You’re hedging your bets. In the rare (likely) case you don’t provide a fully engaging environment for your employees, at least they’ll know they’re being paid fairly. And maybe, just maybe, they’ll look to themselves to find the reasons for their disengagement. It means one less issue, a little more trust and a lot of potential upside.

Okay, protection is in place, but what about increasing workplace productivity?

This question is like asking “how do I lead a team?”… while there is so much subjectivity involved (borne by human emotion and irrationality), the underlying solution is still the same: communication. Don’t just sit their like a typical scheming, self-interested, self-conscious manager, ask your people what they want. “What do you need to be fully engaged, to think of the business like your own, to get the most out of yourself, to gush about your position to your friends, to think of new ideas when walking your dog, to figuratively move mountains; what do you need?”

If they look at you with contempt and put up a stone wall, give it a day to settle and try again. And, if you still get those looks tomorrow, fire them. You’ll be doing both of you a world of good.

Image: What on Earth to do? [source: Shutterstock]

Let’s start with an analogy.

Imagine you’re a rock star. You arrive at a nearby hotel with the rest of your band after headlining a concert. The hotel manager tells you there’s only one room left, and due to high demand from the concert, the last room is renting at a premium. You feel the manager is taking advantage of your fame and extorting you. But, you pay the price anyway because you have no other viable option.

So, how will you and your rock star friends treat the room, given that you feel ripped off?

Simple-minded business people think a transaction ends when the money changes hands. But, it doesn’t. If you’re paying money for a product or service, your perceived value of the transaction will shape and influence your subsequent actions. You may not trash a hotel like a rock star, but you may use the liquid soap in larger quantities, or drink from the mini-bar without paying, or take a little less care when checking out.

The same goes for employees. As an employer, it’s your choice whether you underpay, fairly pay or overpay your staff, but be aware of the consequences. Sure, they can leave if they’re not satisfied, but in private equity and many other industries, work is scarce. There are people out there that will work for a pittance for the chance to enter certain industries. And, they do. But, employers must be careful with this power.

Just as a ripped off rock star can cause calamity, a ripped off employee simply won’t provide value. For example, would you rather pay a CTO $90k to work at 20% of their capacity or $140k to work at 80% of their capacity? For some CTOs, the difference in output (from 20% versus 80% capacity) might be negligible. But for most great CTOs, the difference would reach orders of magnitude. This is the choice you’re making every time you pay a wage.

They may not even know they’re underperforming, you may not even know they’re underperforming, but it’s the risk you take. So, don’t be a manager that underestimates the influence of fair pay. Great people make great companies and great people don’t work at high capacity (or for long) on paltry pay grades. This sounds obvious, but one-dimensional managers continue not to understand the concept.

Image: The pill or the money? [source: Shutterstock]

So, here are a few tips to getting the best exit price for your business:

The Buyer Pool

Financial buyers (e.g. private equity buyers) look mostly at cash flows and likely investment returns. Strategic buyers (e.g. competitors, customers and suppliers) look at synergies, strategic value and brand power. But, don’t only focus on strategic buyers; keep financial buyers in the pool to increase competition and keep options open (financial buyers regularly forgo rationality and become competitive too).

Competition

Competition is good for bidding up prices. But, competition can also deter financial buyers who don’t want to compete with strategic buyers on price. You should maintain ambiguity in the early stages of a sale process and allow buyers to become emotionally attached to the business before stirring competitive tension. Don’t be the real estate agent who announces there are hundred of interested parties. Some buyers will flatly pullout if you announce competition. (Be especially careful with other private equity buyers; they don’t like competition.) Irrespective of the buyer though, focus on the value above maintainable cash flows to elicit the best price.

Expectations

High price expectations can drive potential buyers away. But, low price expectations can set a psychological cap on the price. Again, be ambiguous at first, but aim to set a floor on the price early without actually naming a price. Talk about similar transactions and other subjective measures that help plant the seed for a higher price. This is difficult, but if you’re too ambiguous, buyers will justify a lower price in their own mind and find it hard to move upwards later. Communicate methodically and try not let anyone hasten you.

Metrics

In the early stages, try to negotiate in multiples, as it leaves more room for flexibility. If you set a price at $xm, you give the buyer power to manipulate the deal (e.g. around cash, inventory and debt levels) while maintaining the price at $xm. Sure, you can increase a price, but you want to avoid setting unnecessary psychological caps. However, if you find the buyer is fixated on paying a certain multiple or price, adapt and put your efforts into negotiating on inclusions.

Inclusions

With both metrics, multiple and price, there is a lot of room for manipulation. So, be prepared for various discussions about inclusions, which include fixed assets, cash at bank, earnings normalisations, etc. Understand these subjective factors before talking to buyers and make sure your arguments are rational. Also, make sure you keep a few bargaining chips up your sleeve. (See this post for exactly what to do to prepare your business for sale.)

Integrity

Above all, maintain your integrity, be friendly, be honest, but remember, this is a once in a life time opportunity, so don’t be overly generous. However, if you’re too tough and manage to get an unfair price, you may benefit now, but you may also witness repercussions later. As a private equiteer, you already have more than most, so don’t take unsophisticated buyers (in a transactional sense) for a ride. Keep your spine, be decent, be one of the good guys. This is a controversial point, but I stand by it.

There’s much more to negotiations, but these are the points I thought especially salient for private equity.

During the period of excessive gearing, we all signed up to relatively strict debt terms because, a) we had little choice, b) we had high hopes for the future, and c) these terms still allowed some room for movement. Then, the GFC hit and the usual multiplier effect of diminishing markets kicked in: sales fell, margins fell, earnings fell, free cash flow fell, and, we started to breach covenants. As a result, we all went into panic mode and tried to do everything possible to keep our heads above water.

So, what are you thinking if you’re a bank? How about, “let’s look at our lending book commercially; that is, we’re more likely to get our money back if our customers survive”? Or maybe, “as long as they pay our interest invoices, let’s be reasonable as a sign of good faith for our customers loyalty”? No, what they’re actually thinking is, “this is a perfect time to cash in on all of these breaches by increasing our margins, charging infringement fees and making our terms more burdensome.”

You may be thinking, “what’s wrong with that; they’re a business with shareholders and their customers agreed to these terms”. Well, that’s true, and technically they’re well within their rights to do this, but as I’ve posted ad infinitum, there’s more to business than the immediate bottom line. What this stringency is really doing is creating a GFC aftershock of similar magnitude to the real thing.

Let’s say you’re running a small business. You’re doing absolutely everything you can to survive. Even, laying off workers, taking short cuts and reducing service levels; all pretty risky stuff. Then, you get a letter from your banker (many of them lack the courtesy to call or visit). And, as if you’ve committed some heinous crime, in large letters it mentions the following:

you’ve breached covenants, your margin is doubling, you must pay a fee of $300k for the breach, you now have to report to the bank monthly until they’re satisfied, and, you must engage an accounting firm of the bank’s choice to perform an exploratory investigation of your accounts. Oh…and if you fail to do any of this, the entire facility may be called and you’ll have 14 days to repay the principal.

Do you remember that whole notion of just keeping your head above water? Well, drowning looks like paradise compared to what’s on the horizon. The increase in your interest expense alone is as if you’ve doubled your workforce, but of course the new recruits refuse to do any work. Then of course there’s the fine, which you simply don’t have the spare cash to pay. There’s the half a million dollars (and endless nights) to fund the bank’s criminal investigation. There’s the downtime for most of your crew to deal with the new demands. And, there’s the lost sleep from knowing failure is imminent.

You know, if we were all held at gunpoint and made to choose someone to blame for this whole GFC saga, we’d have to firstly choose ourselves. But, in a very close second place would come the banks. Now, to think they’re instigating this aftershock… well, it just smacks of the same insanity that caused this mess in the first place.

Then again, how many of you have let an investee off the hook come earn-out or equity-ratchet time? (Let’s just pretend I didn’t say that.)

Image: Thanks Banks [source: Shutterstock]

In addition to personal funds, bootstrappers aim to reach a level of cash flow profitability to reduce any personal burden and help the business grow itself. This is very much a major competitor to private equity, as I discussed in my last post, The competitor without a face.

I’m discussing this again because today I came across a few very prescient blog posts that discuss bootstrapping:

Dharmesh Shah at MIT Startup Bootcamp – this is a video of Dharmesh presenting to MIT on startup marketing. In the vid he suggests he’s not so much anti-VC, but anti-VC process. He thinks the likelihood of getting funded is relatively very low, yet the likelihood of wasting an inordinate amount of time on the process is relatively very high. Sage words.

Seth Godin on a Middle-Ground between Debt and Equity – this post discusses an angel-backed royalty scheme for funding. So, rather than complicate the funding process with term sheets, he recommends offering an investor x% of your revenue for $y capital. Sounds simple, maybe too simple, but it’s a good middle-ground nonetheless. The premise is that it not only simplifies the funding process, but also the ongoing reporting process. And while you may lose out big time if you hit the big time, you may also give up the chance to hit the big time with overly complicated funding agreements.

Jessica Mah on Raising Money – this is an absolutely fabulous post from a thoughtful young entrepreneur in the States. Jessica discusses conversations with Customer Development guru Steve Blank, and suggests that many VC-backed startups burn cash on untested and unproductive initiatives. I think she’s absolutely right; there’s often too much pressure on getting big immediately, rather than creating something worthwhile immediately. Her post discusses many other topics, so it’s worth the full read.

In addition to checking out these great posts, consider following these blogs indefinitely.

The problem is that the other guy is often no guy at all. That is, a business may decide to fund its growth using its own cash flow. Such businesses understand private equity is an expensive proposition (i.e. a high cost of capital), so they don’t see the logic in employing external funds if they already have the funds. This may sound somewhat limiting, but with millions of dollars of free cash flow and significant borrowing capacity, most successful businesses can do quite well without external investment.

However, there’s always the what if scenario: what if we had unlimited funding and what if we could achieve world domination? This is where private equity enters the fray. With virtually unlimited capital and an extended team of highly experienced businessmen, there are fewer limits; the sky is the new limit. Additionally, it’s human nature (and the nature of most entrepreneurs) to become more excited about potential upside than potential downside.

So, the decision often comes down to the volume of that niggling voice. The voice that brings dreams into the scope of reality. The voice that feeds an entrepreneurs voracious appetite for risk and adventure. The voice that ignores the size of your offer and currency of your attire. It all comes down to an irrational voice.

Images: Owners of successful businesses have many options [source: Shutterstock]

Swapping Capital

• Transition – many private equity transactions occur because, for whatever reason, there’s a transition of ownership and/or management. We know these transactions as MBOs, MBIs and, of course, BIMBOs (we’ve actually done one of these transactions). The drivers for transition can be anything from an outrageous offer to the current owner simply calling it a day.
• Succession – this is a form of transition, but more specifically involves an owner reaching pension age and passing the business on to family members or new owners. In either case, a private equity firm can sponsor the buyer to purchase the business from the seller. This often works well because the prospective buyer has an entrenched understanding of the business, but doesn’t have the funds to help pay the seller a hefty one-off pension payment.
• Privatisation – we hear about many private equiteers that exit investments via the public markets (i.e. IPOs). But sometimes, if a listed business is undervalued or the private equiteer has lost his/her mind, we also see them enter via public markets. We know these transactions as public-to-private deals. However, they’re not as common as other transaction types because the process can be painful. Apart from needing to convince thousands of stockholders to sell, you often need to pay a premium to convince them to sell.
• Consolidation – sometimes it can be a pain in the backside to have a fragmented stockholder base, even if there are only 5 or 10 investors. In this case, a private equiteer will sponsor a more enthusiastic stockholder to buy-out the less enthusiastic stockholders, giving him/her more control to drive growth. This may also be the result of a succession or expansion transaction.
• Equitisation – this involves changing the balance of debt and equity in a business. Often a private equiteer will invest to de-leverage a business by paying down some of the debt. This may be a turnaround situation or as a way for a business to bring in a private equiteer (for their skill, contacts, etc.) without burdening the company with new equity it doesn’t yet need.

Injecting Capital

• Expansion – this is the typical venture capital scenario, but also a private equity scenario, when a business needs more money to expand. The money may fund plant & equipment, working capital, staff, professional services, marketing, or any number of other needs. In this case, the investment requires the issuance of new stock, often with preferred status. This isn’t as common as one may think (in private equity) because typical private equity candidates already produce significant cash flows to fund growth or at least the interest payments on debt (which we know is much cheaper than private equity). It’s more common in businesses with unstable cash flows, already high gearing, a lack of financial sophistication, or a specific need for a private equity investor.
• Acquisition – this is simply a specific example of expansion funding, but it differs because it often requires capital that can’t be funded by maintainable cash flow. Acquisition funding is a very common driver for private equity funding, and unlike my comments above for expansion funding, it is often needed by businesses with stable cash flows and only moderate gearing.

As you can imagine, most transactions fit into more than one of the above categories. Expansion deals may consolidate the stock register, acquisition deals may involve ownership transition, and privatisation deals can often trigger some form of equitisation.

As a private equiteer, there are many tools in the toolbox, and by using these tools, we can structure deals that appeal to the most stakeholders while also delivering value to our funds.

Images: Capital injections are not the only form of private equity [source: Shutterstock]

(For those uninitiated, Paul is from Y Combinator, an early-stage startup investment firm.)

Here are the points from Paul’s essay that grabbed my attention the most:

• Founders said their number one surprise was how careful they needed to be about co-founders
• Founders were surprised how much more important persistence is than skill and intelligence
• Founders were surprised how long things take, especially when bureaucracy takes hold
• Founders were surprised launching early, learning from customers and iterating really works
• Founders were surprised of the power of engaging customers and changing ideas accordingly
• Founders were surprised that they overvalued competitors’ ideas and overstated the threat
• And of course, founders were surprised that investors are clueless

This last point grabbed my attention because, a) I’m an investor, and b) I like to think I’m not entirely clueless. This then begs the questions, a) am I in fact clueless, and b) does this even matter?

Well, of course I’m clueless about many things, and, I’m usually clueless about the products and services of our investees, before we invest. But, once I  seriously consider an investment, I become an expert, or as expert as one can become in a matter of weeks. I’ll never have the entrenched understanding that comes from 20 years of research, but I can build an appreciation that helps to understand a potential investment, it’s market, it’s customers, etc.

So, is this enough? Considering I’m not the one building the product, it likely is more than enough. My skill lies elsewhere in areas that complement the skills of the founder (or at least that’s my pitch). I know finance, I know deals, I know fund raising, and as a layperson (with regard to an investee’s technology), I also know what the average person wants. And with that, I can just as easily argue that founders are clueless too. Just as investors may be stumped trying to turn a device on, founders interminably build square pegs for round holes.

Apart from persuading you to read Mark’s blog, I want to comment on a few points from his latest post.

• Unprepared potential investors - I admit to being guilty of this myself; sometimes there’s a whirlwind in the office or at home or with an investee, and whomever I’m meeting with next gets the short end of the straw. But, don’t let that deter you. If anything, it makes it easier to impress me because I’m likely caught up in a shit-storm and pining for a few rays of sunshine. So, irrespective of the investor’s preparedness, entrepreneurs should stick to the points that matter. And, if I don’t know the basics of your product or technology, don’t worry, I’ll ask.
• Arrogant potential investors – please don’t confuse unpreparedness with arrogance. Unless investors warn you at the start of the meeting that there’s an impending emergency that requires in-meeting phone use, then they absolutely shouldn’t be playing with their smartphones. Likewise, anything but full engagement is unacceptable and plain rude. The consolation to the entrepreneur in this situation is that they shouldn’t want to work with pricks anyway.
• Unauthorized reference checks - one of Mark’s annoyances was when he specifically asked a VC not to contact a major customer, but the VC did it anyway. This is so not cool. Private equiteers (and VCs) may postulate that the avoidance of reference checks is due to something sinister, but anyone with an ounce of intelligence knows the damage they can do. You could be breeching confidentiality, you could stir competitive tension, and you could endanger current negotiations. (We all know not to drive the Bentley to negotiations, and well, the same goes for announcing an influx of millions of dollars.)

The happy ending to Mark’s recount is that the VC firm apologised and committed to changing its ways.

But… in many cases, it’s the underlying business model, rather than the customer-facing concept, that creates real economic value. For example, a distributed ad network made Google profitable; co-operative field lenders made Kiva’s social concept viable; and affiliate advertising funded TripAdvisor’s rise to the top of the web.

While it may be easy to create traffic from a quirky idea (think Twitter), it takes business model innovation to make that quirkiness last. As the title suggests, the business model is often the humble hero of successful businesses.

So what is a business model exactly? It’s simply the system or framework used to create economic value. A successful company’s competitive advantage must have a distinctive link to its business model. The focus may be on generating revenue, saving on costs, optimising working capital, maximising cash flow or anything that creates economic value-add in a unique manner.

We tend to name our business models (the latest references being to the Freemium model), but generally, you have to do something outside of a cookie cutter approach to continue growth. I know I’m not saying anything overly profound; I just think it’s worth considering your current investees and asking yourself how could you alter their business models in a way that creates unique economic value?