Should your start-up consider a convertible debt deal?

Recently a new friend and prospective client asked me about a financing opportunity that had been presented to his bootstrapped start-up. He asked me the advisability of accepting a convertible debt offer versus straight equity financing. The answer I provided was general, as the question was general, and because I was not familiar with his company's valuations or deal specifics. I am familiar, however, through my experiences with other clients and mentees, and through teaching a small business course, with the options.

Fortunately, my friend’s question was whether or not he should even consider a convertible debt deal, not advice on whether he should actually take it. (That took the pressure off of me.) I assured him that it was in fact a common practice for a firm at their level of maturity and it was likely to be a more favorable solution for them. This wasn’t financial advice (I’m a marketing guy, after all) but I thought I’d share my reasoning more broadly.

Firstly, however, let’s define our terms.

Equity financing is financing by issuing shares of the company. While rumored to be the simpler of the two approaches, at least for mathematics challenged types such as myself, in fact the tricky part for early stage start-ups is determining the valuation of the company. There are as many approaches to this as there are founders and investors (and stages of growth), but through several formulations and more than a little guesswork, ultimately the company value is “simply” the figure investors and founders agree that it is.  Post-investment value is just the pre-investment value plus the investment. It can all contained within simple t-chart accounting.

Convertible debt is borrowing money where your intention, and that of the investor, is not to pay back the loan with interest as in a typical loan, but to convert the debt to equity in the company at a discount (typically 20%). The terms, timeframe, discount, any valuation caps, are all negotiable, and vary widely. The debt also has an option to be paid prior to maturity with an outright cash payment should circumstances change.

So which is better?

To quote my old graduate B-law professor, “it depends” (such was his answer for most hypotheticals).

A main advantage for equity financing is that it doesn’t require repayment like debt would, and is a simple calculation - assuming you can settle on an acceptable valuation. Disadvantages include the need to determine valuation (difficult for young companies) and a loss of some management control.

Convertible debt, alternatively, does not need to have a valuation upfront (it converts based on a valuation from a subsequent round of investment when presumably valuations are easier to calculate) but will need to be repaid, like debt does.  While interest will not (usually) need to be paid in cash each month, there is a limited timeframe before it needs to be repaid, or convert automatically into equity at previously agreed terms. If the latter option isn’t part of the agreement, the repayment requirement can lead to unintended fire sales forced by holders of the debt. Still, as most founders believe their start-up will be worth more at a later date, this approach will result in less dilution, by issuing debt and leaving the valuation flexible in order to meet the requirements of the company and those of later investors. I also understand that this is a faster and cheaper transaction when compared to the legal paperwork of an equity play.

In the end, I recommended he welcome a discussion of convertible debt. But I hope he (and you, dear reader), remember this fine print: I’m a marketing guy. I’ve been brief here, and your circumstances will vary from your neighbor’s start-up, and even change as your company matures. Each company and each stage of growth requires a different type of financing. Ask a professional. Whatever you decide, try to limit the dilution, retain majority voting rights, and use your brain, but leave your ego at the door.

(Finance guys who want to clarify any points in this post are asked to comment.)

Avoiding a 'Nightmare': Small business lessons from Gordon Ramsey

I’ve noticed, from watching too many episodes of Kitchen Nightmares (a DVR is a curse), that all small business can learn something from Gordon Ramsey's formulaic approach to restaurant turnarounds.  The show is eminently predictable  but entertaining nonetheless. It's formula, and it's lessons, are applicable to many small businesses. First, the typical revelations for featured restaurateurs on Kitchen Nightmares, followed by the truism for all small businesses:

·         KN: Your issues are grounded in the fact that you have no prior restaurant experience.

o   A track record and case studies are important tools in selling. Know what it is you are offering your customers

·         KN: You think Gordon will love your food and you just don’t know why business is poor.

o   You can’t be so close to your business you miss the bigger picture.

·         KN:  You will be surprised and angry when Gordon doesn’t like your food.

o   Your business is your baby, but you have to be realistic about how good and how unique what you are providing actually is and be prepared to change. A lack of complaints is not a series of endorsements. Regularly poll customers to identify areas of improvement.

·          KN:  Gordon will not like that you use a microwave and use canned and frozen ingredients.

o   Your offering must be unique to you. What is your vision, mission, your unique value proposition? You cannot simply do the same thing faster or cheaper

·          KN:  You will yell at Gordon and ask him who he thinks he is.

o   Invite criticism. Criticism and failure are difficult but necessary to success. Do not create an atmosphere where employees fear complaining or offering suggestions.

·          KN:      Gordon will find icky things in your kitchen.

o   Stay organized and responsive to your customers.

·          KN:     Gordon may close your restaurant for a good scrubbing if it is extra icky.

o   Remain ethical and fair in all your business dealings.

·         KN; Gordon finally makes you realize some things about yourself.

o   Take time to think, strategize, and redirect.

·         KN: You will agree to start acting an owner.

o   Know your goals, your priorities, and create plan to move forward.

·         KN: Gordon will simplify your menu and feature fresh, simple ingredients from local merchants.

o   Keep it simple, stupid. Always worked, always will.

·         KN: Gordon will update your drab, 80s décor.

o   Thought leadership is critical to your brand. Stay on top of changes in your industry. Better yet, create them.

·         KN: Your service will initially be poor on re-launch night.

o   Change is painful. Change takes time.

·         KN: Suddenly your staff will get it together.

o   Hire good people and trust them to get the job done.

·         KN: Gordon will meet with you and your staff afterward and tell you how far you’ve come.

o   Reward and recognize small wins along the way.

·         KN:  You will hug Gordon.

o   Sit back and enjoy the fruits of your labor.

...and there will be cursing. Lots and lots of cursing.

What are your 'real' priorities? A simple test.

One of the most difficult questions we answer to ourselves are 'what are our priorities?'.

To be clear, that's not, 'what do you say your priorities are', but what they really are. That's the hard part.

To determine how well your stated priorities align with your actual priorities, try this trick: Next time you say to yourself, "I don't have time to... (activity)", change 'time' to 'priority', by saying instead "It's not a priority to me that I..."

It's revealing. And in some cases, disappointing. It quickly reveals the real priorities we've set for ourselves.

Because when the average American spends hours in front of the television every day, its easy to allow time to slip away unnoticed. But time is a finite resource that must be placed into a triage - and that simple change in wording will help you determine if you truly do not have time, or you simply have other priorities.

Next time you miss the kids' school play or ballgame, skip studying a new language, or stay in instead of going for a run, is it really a lack of time, or simply not, truly, a priority for you?

 

Can I hear an Amen?

So, the other day I was thinking about an upcoming sales meeting and product launch plan. My attention turned to sales enablement, branding, and the difficulty in getting salespeople just as fired up as, say, the engineers are, over the latest incarnation of their product. "C'mon, guys, our new AXT4000 Johnson Rod has four times as much monkey oil as the competitor's Johnson Rod!"

Yeah, well, I'm not excited either. And I write this stuff.

So who is excited? Who is so danged fired up that they'd get dressed to the nines and go door to door during their free time to talk to desperate housewives? Who's so convinced of the value of their product that they'd tote their entire families and a forest worth of pamphlets with them to be certain everyone had a chance to share their enthusiasm, including their kids? Who's so completely convinced of the superiority of their value statement that they'd give up everything to take two years to do nothing but sell, sell, sell?

Girl Scouts, Jehovah's Witnesses, and Mormon Missionaries, respectively.

For me I marvel at their commitment even as I brush them off. (I am a salty snack favoring Methodist so thanks, but I'm covered.) When was the last time you encountered a salesperson at your company with the earnestness of a Girl Scout, the persistence of a Witness, or the commitment of a Mormon? Before you complain, maybe you should start with a mirror.

I understand that in technology sales as in other industries, we aren't talking about salvation and deep set belief systems. But that's the point, right? Perhaps we need to approach sales enablement with the fervor of a Chautauqua preacher converting the heathen masses. When was the last time YOU got excited the latest version of software or throughput on a server? And if not, why not?

As you prepare to talk to salespeople about a new product, service, or feature, first answer for them the question they must answer all the time: "Who are you and why should I care?" If you can't answer that with the enthusiasm of an itinerant preacher, you can't expect it from your congregation of salespeople, either.

Even if you threaten their eternal soul.

All Work and No Play

Image via Wikipedia

Tonight, someone owes me an email and isn't delivering. And I don't really mind, because as you can tell by the dates of these posts, its been a month since I had the time to muse over a post so I'll enjoy the rare time. I've been working awfully hard lately, on an interesting but demanding project. I guess it doesn't help that I'm also battling some sort of weird respitory thing and fighting insomnia.

My candle burneth on both ends.

So that brings me to offer this public service announcement for those of you who are weary of the world of work. Yes, I know that we are glad to have a job and feel it unsympathetic to those who wish they had a job to complain about, but as a Forbes ad asked years ago: "Which is worse, to be laid off on Friday or to pick up the slack on Monday?" There's not much to be said about either.

Take a moment and review these websites... and remember to frown into the screen as you peruse these helpful sites. No, not because you'll be frustrated or angry, quite the opposite. Frown so others think you are researching something critical. Because, after all, you will be.

http://my-bad-habits.blogspot.com/ Ian Newby-Clark is a professor of psychology who studies our habits and offers interesting insights as to why we do what we do and why we don't really need to.

http://www.revrun.com/ Philospohy and wisdom from an innovator in the hip-hop movement. (Why do you look so surprised? Because Run has something to say or because I know who he is?)

http://lifehacker.com/ Simplicity for the geek in all of us.

http://www.fourhourworkweek.com/blog/ Author Tim Ferriss is a divisive character, but he's always good for a little wisdom or interesting story here and there.

http://zenhabits.net/ Leo Babauta says it best on his site: "Zen Habits is about finding simplicity in the daily chaos of our lives."

Do you have other insights or websites on self-improvement, life balance, or simplicity? I'd love to hear about them!

Unpopular popularity

"Nobody goes there anymore, its too crowded" is one of my favorite 'Yogis', so named for the famed Yankees catcher who is perhaps as famed for his unique turn of phrase as his play on the field.

In a study released by the Proceedings of the National Academy of Sciences, however, we find that, once again, there is a lot of truth to what Yogi Berra has to say. The study illustrates that the fall of an item or style in popularity mirrors its rise to popularity, so that items that become popular faster also die out faster.

These, my friends, are called fads. The study's authors were quoted as saying that “While it is easy to see products, ideas, or behaviors catch on in popular culture, less in known about why such things become unpopular." And this question is as critical a question to marketers as any.

In a cross-cultural, non-commercial study that harkens to Levitt's book Freakonomics, study authors Berger and Le Mens analyzed baby names in France and the US over the past century. The two researchers found a consistency in the rise and fall of given names - that the longer it took for a name to become common, the longer it took for the name to fall out of use. Parents interviewed indicated that they were simply unwilling to risk saddling their child with a name they perceived as 'faddish'.

For marketers, these results indicate that it is the perception of a trend that makes the creation of a fad self-fulfilling. While somewhat intuitive, there is often no scarcity or other economic factor that forces certain trends that 'hockey stick' in popularity to die out faster. Instead, the concept of 'the harder they fall' is based in the idea that people, for all their concern about fitting in, don’t want to be seen as following the herd. The key is perhaps in not controlling the growth, but in marketing the message - even as sales rise without apparent assistance from 'those guys in marketing' - that the growth is because of the value offered by the fast-growing product or service, and not transient fads.

And that will mean that in addition to trying something, marketing will keep people coming back, even as it gets more crowded.

If you were a tree, what kind of tree would you be?

If your company or product were a fictional character, who would it be? It's one of the questions I ask when trying to determine the intended brand perception for a client. And I get more than my share of rolled eyes from the engineers in the room.

But consider your own response to this question: If you were thirsty, where would you likely find an ice-cold Obama? Next to the Dr. Pepper or nearer the energy drinks?

If you called your friend, would you expect to pick up and dial the McCain or are you more likely to just go online and 'poke' them on Obamabook? Maybe you'd discuss the McCain supertanker that is caught in a storm off the gulf coast, or the latest music player from iObama.

You can think about this when you pick up a snack of some organic dried fruit at Obama Foods for your flight to Chicago on McCain Airways.

Okay, the whole thing is silly. But now reverse that:

If you were thirsty, where would you likely find an ice-cold McCain? Next to the Dr. Pepper or nearer the energy drinks?

If you called your friend, would you expect to pick up and dial the Obama or are you more likely to just go online and 'poke' them on McCainbook? Maybe you'd discuss the Obama supertanker that is caught in a storm off the gulf coast, or the latest music player from iMcCain.

You can think about this when you pick up a snack of some organic dried fruit at McCain Foods for your flight to Chicago on Obama Airways.

Relatively speaking, the former made more sense, didn't it? And it proves out the power of branding on not only our perceptions of products, but perceptions of our leaders, our friends, and ourselves.

This important article was sent to me by a designer with whom I do much of Strategy180's branding work. It underscores the power of branding and how it may not only impact the can of soup we put in our grocery basket, but the future leadership of the world's last great superpower.

Perhaps now you might want to budget for that branding study, yes?

To everything there is a season

Something important to consider in these troubled times - the sarcastic wisdom of my favorite cartoonist, Bill Watterson, speaking through the eyes of six-year-old Calvin:

"Since September it's just gotten colder and colder. There's less daylight now, I've noticed too.

"This can only mean one thing - the sun is going out. In a few more months the Earth will be a dark and lifeless ball of ice.

"Dad says the sun isn't going out. He says it's colder because the earth's orbit is taking us farther from the sun. He says winter will be here soon.

"Isn't it sad how some people's grip on their lives is so precarious that they'll embrace any preposterous delusion rather than face an occasional bleak truth?"

The first time as tragedy, the second time as farce

This, from the New York Times:

"...nearby was Anton Zimin, 26, an advertising copywriter, who said he was quite familiar with (a recently deceased novelist, radical, and historian) but doubted that others in his generation were. He said people his age have lost touch with the struggles of their parents and grandparents.

"The problem is that now, it's all about consumption - this spirit that has engulfed everybody," Mr. Zimin said. "People prefer to consume everything, the simplest things, and the faster, the better."

The radical author to which the 26 year old refers is Solzhenitsyn. The consumerism he laments is not American, as the young copywriter is Russian. He speaks of the consumerism of Russia.

In this age of instant gratification and the global village of modern communication, what it took America to bring upon itself in 50 years of mass consumerism, Russia has done in half the time. In the dog years that technology offers, I figure they'll be mirroring our insurmountable national debt, credit crisis and housing crunch by next May. Sarcasm aside, there have always been those who looked to burgeoning economies abroad and spoke of the opportunities to be had there - and these still exist. Moreover, so do opportunities to do it better this time, correct old mistakes, and find new solutions. Unfortunately, between China's dismal environmental record and Russia's corruption, this opportunity may already passed for those countries' leaders, but not yet for the companies looking to build a better world there, and back here at home.

UBS: Uncertain Brand Strategy?

Peter Kurer, chairman of the bank UBS, which is arguably the world’s largest wealth manager and the bank most highly leveraged in sub-prime mortgage loans, was recently quoted by Reuters as suggesting that the damage to their reputation (read, brand) from the sub-prime mess will “go away after two or three years”.

That’s not brand management, that’s brand abdication. “Goes away?” Brand reputations don’t “go away”, they are merely replaced by new perceptions. What has Kurer in mind for replacing a brand perception damaged by $37 billion dollars in asset write-downs and two recent requests for emergency cash infusions?

Time heals all wounds? Not so fast.

Small gods

I recently discovered that a friend considers himself a Luddite because he has so far resisted the seemingly inescapable social pressure to own a mobile phone.

Having just returned from CTIA, where the discussion among the assembled wireless companies and network equipment providers was once again on the subject of providing more data access, services, collaboration on mobile devices - and I feel somewhat like an anthropologist among the crowds because I still know at least one 18-49 year old without mobile service at all. That's right, forget mobile internet and collaboration apps... he is lacking even simple mobile voice communication.

Actually, I am very sympathetic - and in fact envious - of my friend's postion on mobile phones. As Jerome Lawrence wrote for the play Inherit The Wind, "Progress has never been a bargain. You have to pay for it. You can have a telephone, but you lose privacy and the charm of distance. You may conquer the air, but birds will lose their wonder and the clouds will smell of gasoline."

Today we clone livestock and can grow a heart in a petri dish. We 'google' or 'wiki' information at our fingertips and can quickly become a skeptic, if not an expert, on any topic under the sun. We live and work in orbit 220 miles above the earth. We TIVO our favorite programs and thus appear to control the fabric of time. This week, a 'man' even announced his pregnancy.

Mobile phones have already allowed us to master the concept of being omnipresent. Success with these other endeavors will bring us closer to be omnipotence too. Small gods, each one of us.

So I cut my friend a break. Those who refuse the latest gadgets aren't Luddites. Just human.

Know thyself

"The essence of leadership today is to make sure that the organization knows itself." -- Mort Meyerson

This statement by Perot confidant and former EDS Chief Executive Mort Meyerson is my advice for you in 2008. Not far from the platitudes “Know thyself” and “To thine own self be true”, Meyerson’s statement emphasizes the importance of a widely understood, and closely followed corporate Vision that drives a firm’s mission, principles, and strategic direction. An organization that knows itself knows how to spot opportunities, navigate troubled waters, and work together toward common goals. For individuals, it helps define roles and responsibilities, establishes their individual value to the organization, and builds the foundation for empowerment in decision-making.

To thine own company should each employee be true.