Venture Capital is Still Out There

10 October 2008

In the last few days there have been a number of posts about a venture capital crisis yet there are still venture capitalists out there, looking for good opportunities.  Here are a few of the doom and gloom posts from Michael Arrington at TechCrunch:

On the positive

Despite the positive tone, getting financing these days is going to be tougher.  The WACC has gone up.  Plan accordingly.


Alternatives to Layoffs

8 October 2008

If you are preparing for the downturn by cutting costs, consider the advice of Mike Elgan.  In his article on “Three Ways SMBs can Survive the Economic Meltdown“, Mike highlights three alternatives to layoffs that can help reduce the overhead costs of running a business:

  1. Send people home.  Companies often consider transport and associated costs as included in employee pay.  Consider cutting a portion of this pay and let employees work from home.
  2. Use all the on-line tools to travel virtually and collaborate without actually leaving home.
  3. At the extreme, consider closing your office and becoming a Bedouin organization.

I like these ideas but I have to ask, why wait for a downturn?

Remember the Dollar?

8 October 2008

It wasn’t long ago that the strength of the Canadian dollar compared to the USD was a source of major concern for Canadian manufacturers.  With the recent turmoil in the markets, the Canadian dollar is weakening again as traders speculate that the recession will reduce demand for the commodities, oil in particular, that are the backbone of the Canadian economy.

USD/CAD currency exchange prices over the last few years.

USD/CAD currency exchange prices over the last few years.

I’m sure many in the manufacturing sector are torn between the impacts of the recession and the benefits they will get from the weakening dollar.  To survive the plunge in the US dollar from the heights of 2002 when it was trading at over $1.50 CAD to the lows in November 2007 when it hit nearly $0.90 CAD, manufacturers that sold into the US economy had to become very efficient.  It was essential to manage Canadian dollar costs to ensure profitability.  If goods were sold in US dollars, there was a double impact of falling revenue in Canadian dollars.    Many were forced to raise the prices of the goods they sold into the US.  A strengthening of the US dollar will reverse these impacts and the now efficient firms will benefit.

For most of 2008, the dollar has been trading near par but it has risen nearly 10% to $1.10 in the last three months.  [Update: As of the 10th October, the USD/CAD rate had increased to over $1.18]  That has to be a relief to manufacturers that sell into the US.  It represents free revenue in foreign exchange as well as the opportunity now to reduce US prices in the face of a recession.

The question is whether the recession will have more of an impact than the dollar.  My own guess is that the coming year will be a bad one and that the Canadian economy will again start to look good compared to the US which will reverse the trend in the dollar.  So enjoy the bump while it lasts but don’t depend on it.  More belt tightening will be required in the future.

Buffett’s Law and Cloud Computing

6 October 2008

In an interesting post on the future of Cloud Computing, Jake Smith says that one of several antecedents of wide-spread cloud computing is the impact of “Buffett’s Law”.  Basically, the law states that Warren Buffett, the billionaire investor is driving change in the business world through the principles of value investing in ways that promote conservative innovation as opposed to radical or flamboyant visionary creation.  “The value of an enterprise is a direct correlation of it’s ability to deliver consistent return on invested capital, regardless of market conditions.”  What does this mean? 

Return on Invested Capital (ROIC) is a measure of the ability of a company to generate EBIT or earnings before interest and taxes compared to the amount of investment in long term debt or equity.  To maximize the ROIC, the company must do two things:  first, maximize its operating profit which translates to maximizing sales, minimizing the cost of good sold, minimizing the overhead involved and working with a low tax rate; second, the company must minimize the debt and investment required which translates into minimizing the working capital requirements and the non-current assets.

The first part is about efficiency of operations.  The second part is about business models.  Efficiency of operations is the realm of lean manufacturing – a philosophy of organizational efficiency that can be applied to just about any process.  Business models relate to how you make money and the decisions about what you do and what you outsource.  Take the decision to outsource PCB assembly rather than purchase the equipment and build the components in house.  If the cost of goods remains the same, out-sourcing is preferred since it lowers the non-current assets which will result in a better ROIC.  To make the purchase of the PCB assembly line attractive, the cost of goods would have to drop significantly compared to what could be produced through outsourcing in order to generate the same ROIC.

How does this apply to cloud computing?  Cloud computing is essentially an outsourced IT model comparable to the outsourcing of PCB assembly.  The cloud offers lower infrastructure for similar performance which means that, even if the cloud is just as expensive as tradition IT, it will be a preferred simply because it lowers the ROIC – hence the impact of Buffett’s Law.

For more on the trends in cloud computing read Jake’s article here or my own take on the changes in IT here.

MJM Consulting – Helping companies grow.

Open Source Software: an Inferior Good

2 October 2008
Image from “Romance gets a market correction”Please have a  read of Steven Vaughan-Nichols’ blog Lets Talk Cheap Software.  The comments are especially good.His point is that, in these turbulent times, expensive software licenses and contracts are not the place to put your money.  If cash is now king (but hasn’t it always been?) it is better to trade effort for a product than cash.  With open-source software, their is little cash outlay but you do have to spend the time to learn how to use it.

Like most inferior goods (I’m using inferior in the economic sense – see wikipedia definition here), open source software may not be seen as an attractive option when times are good.  When you feel rich, you have options.  It is easy to throw money at a problem and buy the expensive stuff and the consultants to install it.  On the other hand, when times are bad, throwing money may not be an option and is likely a dumb move in any case.  Its in the bad times that open source software is an especially attractive choice.

This doesn’t mean that you have to put up with something less, just something different.  An attitude adjustment is required.  Like in the article in The Globe And Mail today “Romance gets a market correction“, don’t worry that because you can’t afford expensive dinners any more, your marriage will suffer.  If you think back to when you were young and at the beginning of your relationship, those were happy times.  “You were pretty close to broke, but you were having fun.”

MJM Consulting – Helping companies grow.

The Mechanics of Money: Building Business Plans

26 September 2008

Any business plan needs proforma financial statements regardless of whether it is boot strapped or VC funded. As the owner, founder CEO, your plan must show that you are going to make money and show it in a way that other people can easily understand it. Financial statements are the key method.

(Dear reader, if you are an accountant, please read no further, it will be a waste of your time. If not, I am assuming you have a basic understanding of accounting processes.)

Generating proforma statements is not a trivial undertaking. Fortunately, spreadsheet software was invented for just this purpose which makes the complexity much easier to handle. They key to designing a good set of proforma statements lies in understanding the mechanics of how value flows around the various accounts on the financial statements. Peter Kemball, CEO at Acorn Partners, likens this to a plumbing problem. Its is a good analogy with lots of fun clichés. Use your house as an example. Water (value or wealth) flows in and flows out. Within your house, you have reservoirs (accounts) where water can be stored and pipes (the rules) which govern the flow around the system. The goal of business is, simply put, to keep more water flowing in than flows out until the house floods (which, in the analogy, would be a good thing).

Note that in the analogy, water is equated to value not cash. Cash is just one “reservoir” of value but there are many reservoirs in the company where value is stored. So, as well as cash flow, think of value flow in the company. If you can keep increasing the value, you can likely find ways to manage the cash flow. Value can be monetized and converted to cash if need be. The clear default for startups is converting equity to cash by getting investors to join the company but it not the only choice. You can also convert the value in your accounts receivable to cash using Factors or speciality investors. Sell your future subscription income, trade on tax credits – it is all possible. This is one area of accounting where creativity pays.

In designing your financial plumbing, you need to select the accounts to use and the rules that govern how the money will flow around. These decisions will eventually drive the selection and setup of your accounting software. Are you, for example, running a product business which will require inventory with accounts for finished goods, work in progress and raw materials or is the business based on a service model with no inventory? It is important to define these at a rather low level but not so low that the account becomes trivial. The point of this exercise is not to create a Rube Goldberg contraption, but to manage the complexity of the whole by breaking it down into small and simple components that are controlled by your assumptions.

Some key assumptions include:

  • Growth rates and revenue
  • Cash conversion times
  • Fixed, variable and semi-variable costs
  • Fixed asset costs & depreciation
  • Interest rates
  • R&D, Marketing, Operations and Administration costs and time lines

Once you have the plumbing designed you need to translate the design to your financial spreadsheets. Here are my key time savers:

  • Don’t worry about format of the working sheets.
  • Keep all your assumptions on one sheet along with the key summary performance graphs and data generated by the other sheets.
  • Each account needs its own sheet. Columns are set up as weeks or months and rows are the elements of plan that affect that account.
  • Some costs are too complex to model within an account. Use separate sheets for these and then link the costs back to the relevant accounts.
  • The sheets used to display the summary financials should only have links and calculations on them – you should never have to enter values on them. The balance sheet should draw all its information from the subordinate accounts with the exception of cash and retained earnings which come from the cash flow and income statements respectively.
  • Get the model working before you try to make it presentable. By working, I mean the balance sheet should always balance as you change the assumptions.
  • Generate several sheets for the presentable financial summaries and tables that you can link to in your business plan documents. Spend the time to make these sheets look good.
  • Keep data in one place. Use DDE or ODB links to connect the spreadsheet model to your documents so that the documents are updated automatically. As much as possible, keep the text in your documents vague and refer to tables and graphs that you have linked to. This will save lots of time in revising the words as you modify your assumptions.

Once all of this is done, you will have a solid model on which to assess your assumptions and build what-if cases. While you may start out with good guess at what the critical assumptions are, the model will help you identify just how critical they really are. It will also help you determine how much cash you will require to succeed and the creative ways you can use to get it.

MJM Consulting – Helping Small Business Grow.

Financial Socialism: Where are the reactions?

22 September 2008

I can only imagine the technocratic twists and spin going on in Washington as a hard-core conservative republican government tries to justify such a massive bailout of the US financial system.  How can they explain the nationalization of banks and the purchase of mortgages that turns large swaths of the US into public housing?  It seems so – socialist.

The mainstream media has reported the postivie impacts – renewed confidence and stability – but I have seen little of the public or political reaction to the stories.  (This AP article shows some of the “Editorial reaction to $700B bailout plan“.)

But back to the spin.  This war on financial plundering will not be tolerated.  America will fight this war and will not allow greed, capitalism or excessive risk taking to impact the American way of greed, capitalism, and excessive risk taking.