(This article was also been published by COSE Mindspring (the source for small business insight in Northeast Ohio).
Making money - this is the basic premise on which most businesses operate. Investors want a return and businesses need a process to produce it. The business/organization may have a higher calling to improve society or serve a given group; however, the vast majority of businesses are in it for the money. Even if they are a non-profit, they still need money, donors and strong fiduciary controls to insure they have the money they need.
The fact is, we need money to run the operation, to grow and expand. That money is also supporting the principal stockholders, the owners and also the employees by putting money in their pockets. I will avoid the lesson in economics and the flow of money in a free market society. However, I do want to further explore the concepts tied to building stockholder wealth and keeping a business or organization viable. Of course there is an axiom that “you need to spend money to make money”. Since we agree there is a need for money to run the business, then on the opposite side of the equation there is also a need for a return on investment for those who provide the funds.
How do you get a return? If you put money into a business enterprise as an owner, partner or outside investor, you have an expectation that you will enjoy a gain on this investment. Obviously, there are those investors who, in essence, are “gifting or donating” their funds to help a family member or close friend get started but the vast majority of money is treated as an investment with a return.
So, as a business owner, where does the money for running the business, growth, expansion or even survival come from if not from within the current operations? Certainly banks remain a prime source for these funds. Their return comes from the legal agreement that requires the business to pay fees and interest and ultimately repay the amount borrowed. There are other sources as well – individual investors, pooled investor groups such as “angel funds”, venture capital and private equity firms.
Let’s look at venture capital (VC). This is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in. Venture capital is a subset of private equity. Therefore, all venture capital is private equity, but not all private equity is venture capital.
In addition to angel investing and other seed funding options, venture capital is attractive for new companies with limited operating history that 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. In exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists often get a significant portion of the company’s ownership (consequently value) and they then will often get significant control over company decisions.
There are typically six stages of venture financing. They tend to follow the development stages of a company.
- Seed Money: Low level financing needed to prove a new idea, often provided by angel investors or even “crowd funding”.
- Start-up: Early stage firms that need funding for expenses associated with marketing and product development
- First-Round (Series A round): Early sales and manufacturing funds
- Second-Round: Working capital for early stage companies that are selling product, but not profitability yet.
- Third-Round: or Mezzanine financing, this is expansion money for a newly profitable company
- Fourth-Round: or Bridge financing, is intended to finance the IPO process
In all cases, regardless of the funding type, the expectation is the same. The “portfolio” client does well and the investors all receive the rewards of making a good investment. Unfortunately, not all of these investments have success stories tied to them. Certainly, there were huge success stories for venture capital and private equity firms during the Silicon Valley Tech Bubble but there were failures too.
How can a VC or PE investor “insure” their client’s success? They can help run the company or they can implement a total performance excellence program like Six Disciplines in their portfolio client companies. Since everyone loves a success story, let me share this one.
In 2009, CapitalWorks, a Cleveland, Ohio based private equity firm, introduced Six Disciplines to one of their portfolio clients, Bluffton Motor Works, a medium-sized manufacturer of electric fractional horsepower motors. The Bluffton leadership team was newly installed and CapitalWorks determined that what Bluffton needed was a structured approach to strategy development, plan execution, and performance management. As they say “the rest is history.” (See the Bluffton Motor Works - Six Disciplines Case Study.)
The Bluffton team implementation under the leadership of their president, David Nussear, has been text- book. They have had excellent follow-through, and as a result, superior performance against all of their key measures – revenue and profitability achievement, market share growth and improved production – quality, timeliness, cost. Nussear said:
“If I knew then what I know now, I would have started using Six Disciplines a year earlier and not lost a year. They have been able to facilitate the planning process in an organization with several type "A's" each wanting things their way. It was the challenge of these differing views that prevented past attempts that were tried internally.”
Dick Hollington, President of CapitalWorks, views their choice to engage Six Disciplines as a major strategic advantage to their portfolio company success.
“Working with Six Disciplines has allowed us to offer our portfolio company management teams a proven process to develop strategy, define priorities, align resources and attach accountability to execution and results. Bluffton’s success is attributable to the team’s focus and execution against a solid plan. The Six Disciplines process improved their ability to do that and changed their trajectory. The team hit on all cylinders this year in achieving strategic objectives and financial results. The Six Disciplines structure and process is an extraordinary advantage for the size of businesses we invest in. Our companies receive the type of performance excellence coaching and support that is generally only found in much larger businesses.”
The key is finding an approach and performing the activities consistently. Even if you don’t have a group of investors looking over your shoulder, working to build a better business to produce better results is an honorable objective. Producing strong business results is the goal and profit margin or balanced budgets (NFP) are not dirty words. After all, we are all in it for the money.