As a private equity executive who has been involved in a handful of independent startups in addition to building wholly owned entities at AT&T and ComcastNBCU, I get more than my fair share of calls from entrepreneurs. Typically, those queries fall into one of three groups:
People in the first two categories typically find someone else to fund their early-stage ventures. However, people in the third group are interesting to me for a couple of reasons. First, it’s hard to profitably run a growing company. It takes discipline, focus, and good instinct. It also takes self-awareness to recognize that building a business may involve skills the entrepreneur does not possess. Asking for help is a great sign of willingness to seek solutions outside the company.
It also takes self-awareness to recognize that building a business may involve skills the entrepreneur does not possess.
I am an operator first and a banker second. I thoroughly enjoy the process of developing revenue streams and products, and if I am going to work, that’s what I want to do.
Why do entrepreneurs sometimes struggle when they reach an inflection point? There are a variety of reasons but in my experience, they tend to fall into one of three buckets:
Since inertia is something only the entrepreneur can overcome, I’ll focus on business and financial risk. Mitigating decision-making risk can be addressed a number of ways, including:
Mitigating financial risk is a more difficult proposition, but entrepreneurs have resources: Lean on strategic investors and your financial partners to guide your company. They know the industry and/or are an important part of your company’s success—listen to them.
Involve your management team in exploring growth options and give them the freedom to think outside the box. There are no bad ideas. If you create an environment where employees feel it’s ok to experiment unsuccessfully, you will foster responsible risk-taking.
At the end of the day, cash drives growth. From strategic investors and community banks to venture capital and traditional private equity, look for money that offers relevant experience you can tap into.
For many entrepreneurs taking their company to the next stage involves venture capital. Venture capital is a form of private equity that focuses on growth companies who are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. What tends to be forgotten is that venture capitalists don’t invest in growth companies because they want to see the entrepreneur be successful—they are there for the promise of an outsized return. In exchange for their investment, VCs command significant control over company decisions and often acquire an enormous chunk of the companies' stock. To justify their demands, venture capitalists like to point to successful unicorns like Facebook, Airbnb and Uber, all venture funded. What the VCs gloss over is just how much strategic and tactical counsel those venture capitalists provided the firm's executives. Unfortunately, the trend of trimming operational partners that started with the global financial crisis of 2007-2008 has only accelerated. In the last 12 years, the operational expertise that once defined venture capital has all but disappeared. The term “venture capital” doesn’t mean what it used to mean.
Another pain point in venture capital relationships is the balance between the efficiency of “boot strapped” management and the risk of amateur decision-making. Growth companies by their nature are cash-constrained beasts that rarely have the luxury of hiring people for the future—they have to hire for the problems they have today with the budget available at the time of the hire. If the entrepreneur doesn’t have the money for a CFO or a controller, they hire a bookkeeper and assume the duties of the CFO. Undoubtedly an admirable, penny-pinching quality—it’s hardly a long-term fix. Venture capital often fixates on an entrepreneur’s ability to recognize who and what is needed when it is needed. If the VC deems the entrepreneur deficient in this regard, the journey from start-up to high-growth company may take place with someone else at the helm. So what is an entrepreneur to do?
While venture-only firms may invest in many early-stage companies with the hope that one or two of them explode, private equity firms are more diversified and also look for successful firms that need assistance growing top line or improving profitability. Where venture capital hunts unicorns, private equity firms are usually more interested in finding consistently profitable investments where their experience and capital can drive growth and profitability in a shorter time horizon.
A number of private equity firms provide fractional executive services—operational experience and strategic insight—as a core element of their investment. While cash is king, entrepreneurs who carefully select private equity partners that align their compensation with the entrepreneur’s interests are in a much better position to reach their company's goals.
What kind of operational support should entrepreneurs expect? Even startups need financial oversight. Somebody must keep the books and help the entrepreneur navigate the financial future of the business. Negotiating the time between Seed Round and A-Round, finding a line of credit, ensuring tax and legal compliance, and simply managing cash flow, the entrepreneur needs straight financials that tell a compelling tale. While a full-time CFO and controller may be overkill, a private equity partner should be able to provide one or two days a week in a reasonably priced Services model.
With a limited product offering and a handful of clients, it rarely makes fiscal sense to hire a full-time CMO. That being said, advertising, leveraging CRM tools, pulling client feedback in from sales, identifying customer requirements, and communicating that information back to the product and service groups is imperative to the success of the company.
Advertising and public relations agencies offer a solution, but the person who “wins” the account is rarely the person who works with your company on a daily basis. A true private equity partner will bring executive talent to the table to help the entrepreneur make better decisions. Such fractional executives are an economical way to access years of experience before the company is ready to hire full time C-level resources.
What a company does for a living can be a fluid discussion. What is the benefit developing a new product line in-house? What are the risks? How drastically will the loss of control associated with outsourced logistics affect my customers’ experience? Does the sales force have the right people on board? Does the product group need fewer development teams and more quality control people? Such core operational problems keep entrepreneurs up at night. A private equity partner who has extensive operational experience in the entrepreneur’s industry can help the company find solutions that work for clients, suppliers, and the business. Providing assessments, analyzing operations, and helping the entrepreneur understand the ramifications of decisions is an important aspect of any relationship with a private equity firm.
At the end of the day, the market cap associated with an investment or exit strategy is based on the perceived future value of the company. Where will the company be in five years? What does the product/service roadmap look like? Why will customers be buying its services instead of its competitors’? What industry trends or pressures will likely affect the business? Will there be new market entrants and how will their presence affect the company? When an entrepreneur has experienced resources at their disposal, that strategic insight can fuel better decisions and lift enterprise value. An entrepreneur’s private equity partner should work closely with the company to prepare for the future.
Some entrepreneurs are looking for a magic bullet to solve all their problems. “If I only had a new revenue stream, or if I only had a better CTO,” are comments I hear all the time. Unfortunately, there are no magic bullets. Leading a successful business takes discipline, focus, instinct, and a fair share of luck.
Make no mistake about it, the key word in the previous sentence is leadership. Leading means delegating responsibility, not accountability. At the end of the day an entrepreneur has to choose whether to go it alone or bring on partners. One of those partner options is to form a relationship with a private equity firm to address common problems that block the path to continued growth. If you can convince the private equity firm to align their compensation with your goals, your chances of success are substantially greater.
Remember that you can’t do everything yourself. You have to trust your people to know what needs to be done and let them do it. Working with a private equity partner that understands your needs and has the operational background to provide you with capital and “boots on the ground” experience can be a life-changing decision for entrepreneurs.
Frank Foster spent twenty years in the media and advertising industry before joining the private equity space. Frank was the co-founder of media research pioneer erinMedia with Brett Price, employee No. 8 at AT&T AdWorks (now Xandr) and co-founded Crossbeam Media at ComcastNBCU with Himesh Bhise and Kevin Smith.