The Money Chase: Breaking the Truce

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Changing the Team: In the beginning, investors fund a business because they believe that the management is capable and trustworthy. If they are professional investors, they establish well-defined performance metrics for the team and company. Failure to meet these performance metrics will undermine this trust. If the investors are less professional, they will have only vague performance metrics. But even these can go unmet. In both cases, evidence builds that the company is not going to be successful. The first tendency of investors is to look to the team. Sometimes they come to the conclusion that major surgery is necessary; as either an alternative or precursor to recapitalization. They may focus on individual members of the team or entire groups within management. The result is an intention to ‘shake things up’. This response often occurs when a company has burned through the initial investment and is seeking follow-on commitments. Such requests give the investors pause and cause them to focus on the performance of management. Changes are in the wind. This often involves substantial changes in the management team. They will identify team members who are not pulling their weight. This could range from the CEO, who is not leading and motivating the team, through the CFO or controller, who is not maintaining adequate records. The rule of thumb is that, once this process begins, it usually results in the departure of a major chunk of the team. The greater the short-fall against expected performance is the more radical the changes that the investors are likely to insist on. The net effect is that the investors, not the CEO, will be calling the shots.

Changing the Value Proposition: If the team has been doing its job well but is not getting traction with customers, the investors may decide that the original vision of the founders was wrong. They will go back to the business plan and projections with the intent of finding where the company started to go off the tracks. This occurs when a core technology or service can be attractive to a range of customers. A company may have started with a focus on a particularly industry; only to find that potential customers do not have the ability to purchase it. Investors will drive management to reconsider that focus and shift to another group of potential customers. Once a new focus is agreed upon, there will be changes in the team; mostly driven by the needs of the new client base. Business development is one area that will feel the brunt of such a change. Marketing may be another. Shifts in value propositions almost always bring changes within the management team.

Increased Oversight: In most start-ups the board of directors is relatively inactive. Initially, investors are not very interested overseeing the day-to-day operational of the company. They may take a seat on the board and will normally be satisfied to have a say in the strategic direction of the business. Oversight might include capital expenditures above certain dollar limits, decisions about expenditures for new product development, significant expansion of existing facilities or establishment of new ones, the sale of major assets, the formation of joint ventures, and management of the company’s credit lines. Most management benefits by the discipline imposed by external oversight and from the experience of the board members. They can bring valuable experience and skills to the business and may sometimes even take on a semi-executive role, if so required. This arrangement provides the company with skills which it may otherwise not be able to afford.” However, if the investors begin to worry about their investment, they will move to increase the oversight of the board. That is to say that, if the investors come to think that the company might be saved, they may reorganize the board. At this point the board becomes much more pro-active and invasive. Management will be asked to brief the board more frequently and in greater detail. Their decisions will be much more carefully and thoroughly reviewed.

The Shifting Balance

Entrepreneurs can go into denial when things start to go off the tracks. They look for reasons and think that having reasons is enough. This is a major mistake. Investors will not see it that way. For them, excuses are an unacceptable substitute for projected results. As the signs that the uneasy truce is starting to break down accumulate, management needs to conduct a clear and open gut check. The road that such a breakdown leads along is fairly well defined and none of the results are as favorable to them as getting the company back on track. It is up to the team to keep the investors in their ‘money managers’ role. The only reliable way to do that is to meet or exceed expectations. When the signs of stress start to appear, most of the options are in the hands of management. The longer these stresses remain and the more they increase, the greater the shift in prerogative to the investors. Unchecked, all of the cards will be held by the investors.

© Dr. Earl R. Smith II

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Related Articles:

• The Money Chase: Oil and Water

• The Money Chase: Should You

• The Money Chase: One Way to Avoid Being ‘Avoided’

• The Money Chase: Who They Do Not Invest In

• Funding Strategies for New Businesses

• Angel Investors to Avoid

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Contact Dr. Smith

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The Federal Circle provides advisory services to companies working in the federal contracting space. Its core team and network of advisers has a deep understanding of the government contracting space. Together they represent a rich resource for companies trying to generate traction in these very competitive markets. Contact us for a free initial consultation.

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