Lessons Learned: Private Investor/ Equity/ Venture Capital- Backed Disruptive Market Start-Ups

Working in a pre-revenue/ loss making disruptive market start-up is very often partially Private Investor/ PE/ VC backed can seem attractive to many experienced and seasoned Senior Finance professionals. This often entails reviving ailing companies for numerous reasons- one is sales. In other instances, it may mean participating in the development growth plans whilst being tasked with identifying opportunities for both cost control and improving operations.

There is no guide, no book, no nothing, with co-founders often working for free, with a pre-conceived idea that “they will be billionaires in a years time”.

PE/ VC backed business means putting your skills to the test, transforming a business, to open doors for achieving greater impact in the future, with some perils attached. The skills and knowledge that make a senior finance professional successful become key where borrowed capital means the risks are larger, a need to show results in a shorter time frame and the scrutiny from the investor.

I have noticed that PE/ VC firms that trust the management teams they have in place either want to be involved in the financial aspects or be hands-off when it comes to communications and guidance.

Typical tasks often include implementing new processes and controls and transforming performance- with a very small or non-existent finance team, that requires them to put fires out. Every day brings a new challenge and excitement is a good way. I believe that focusing on four main priorities¹ can help ensure success in PE/ VC backed companies. Specifically, finance leaders will need to get up to speed on the economic fundamentals of the business; identify the gaps in their people, systems and processes; establish a reliable fact base for making critical decisions and actively lead on the transformational change.

Company Fundamentals

It is important to understand the PE/ VC backed company’s balance sheet and cash flow as well as its debt covenants/ convertible debt and the dilution factor on ownership and control.

With accreting debt levels of the investee; PE firms will want to see cash flow in a far more detailed way, perhaps weekly or even daily reporting on cash.

Details of what creates value and costs whilst having a very sharp handle on fixed and variable costs that reveal what matters most in the business’s operating leverage- will be very important. The biggest challenge often faced is IT/ system issues (disparate system applications and spurious excel workbooks) and cultural issues (isolated and protective areas), both of which limits access to critical data. This information will be obvious or that pre-existing reports will help the finance leader understand the business—or even tell a consistent investor story. Inertia is usually the main reason for boundaries among various business areas.

As an example, I was tasked with trying to pull all cost data for a client company’s product but the IT systems were too antiquated and there wasn’t time to do extensive manual clean-up. Instead, I created a standard-cost model that commercial operations could apply, with various adjustments/ add-ons, to the array of the company’s products. Moreover, past data did not exhibit normalised costs either, where cost plus mark-up previously used created under-priced sales leading to losses, because no detailed understanding of the cost drivers was properly carried out. While I admit this was not precise on questions on profitability, my model did, however, reveal that various categories of products were significant loss-making—largely because their prices failed to account for all inbound/ outbound logistic costs, FX rate fluctuations and being double charged for components from two suppliers. Eliminating and questioning costs anomalies entirely and separately charging for delivery charges for products into various tiers helped the company stop haemorrhaging its cash position. The product costing model then allowed the finance team time to refine the model further by reviewing it for a newer product line.

People

The fast-paced environment and challenges of working in PE-owned companies, often means the management infrastructure can sometimes be in a state of flux, with investors demanding results and progress yesterday.

Not for faint-hearted or wilting flower- oh no!

As a consultant- outside observer, I usually figure out which people do what and make a beeline to gather intelligence. Very often in PE/ VC backed business, skills matter much more than job titles. For instance, a former client changed their mind and decided overnight that an IPO was premature and that the investor story was too weak to make it fly- must be something I said. Instead, they opted for a second pre-funding round with a roadmap on what they were going to do with the funding and set themselves specific targets to grow and make their presence known in the market to tell a consistent but progressive success story.

Data, Systems and Processes

I cannot emphasis enough as an outside consultant, at least initially, that the business leaders must have reliable fact-based data for uncovering new opportunities to create value- which can be captured quickly and reliably. Sadly, most PE/ VC owned companies/ start-ups do not have good data readily available; if they did, well that’s a different story.

Client question always starts with, we would like X, Y, Z, but they often lack the data to enable any analysis to take place nor track capability required to strive for value creation.

Moreover, a PE/ VC firms time horizon usually means that a one-year plus rollout of a new ERP system will not be feasible, even if it was highly desired, where there is no ROI- capital rationing. Understand where and the how to use low-cost digital applications to maximise benefits in months rather than years, is achievable as long as the base ERP and master data is properly set up at inception and under the correct GAAP- FRS101.

For example, I put forward recommendations to a client for small targeted investments in productivity-enhancing application tools, such as off-the-shelf, cloud-based sales and payables management software, including scanning stock/ inventory management that reduces the time, hassle and grief while increasing transparency and procedural policy enforcement. How, you ask? Simply by looking at the data demands and wants that will deliver high-value, quick wins in the near term while also getting other mid-term and longer-term projects on the roadmap, when the business become more cash generative and profitable, as a sensible approach.

Transformational change

The transformational change requires defining KPIs and monitoring metrics in ways that are robust but not arduous to collate, compile and calculate. Most PE/ VC firms will have identified their investment target and will want to see an increased run-rate, where understanding how value is created on both the cost and revenue sides to achieve the desired outcome will be looked at with scrutiny and debated.

Where prefunding is critical for survival and a robust source and uses of funds will be examined under the microscope, forecasting EBITDA, but more specifically revenue in starts-up can be prove quite difficult. Will let’s face it, these businesses will tend to be valued on a revenue multiple, rather than EBITDA run-rate, as the opex costs at inception are usually abnormal/ not-normalised. Questions around the “How” tend to be asked, with no past history to go on, no market trends or equivalent competitors to provide a helpful steer on direction.

One approach I explored² and used at client businesses is to adopt a SPIRIT©¹ approach to help make rapid progress in navigating the need for urgency during times crisis. Implement these steps (explained in brief) will ensure the strategic business plan is aligned with modern day FMCG consumer purchasing trends and habits.

My unique approach requires organisations to adopt new ways of working by using agile and lean techniques, where numerous mutually exclusive sprints are required, with obvious dependencies. Success is only possible if a cross-functional team sit together, where recommendations and decisions based on the latest available data, even if the information is imperfect is used. The art of nowcasting¹ is then applied (dynamic factor modelling) that embraces a range of ubiquitous multivariate data to extract signals about the cause and effort on given KPI’s or demand forecasting, using statistical analysis. The diagram below provides a brief illustration of the approach.

Note a SPIRIT re-run can also help manage performance during and after a crisis, companies should consider these bold actions that they take now to help reshape their business fortunes. Alas, dedicated resource for project planning and execution² is a must for it to yield results. While these types of bold moves will vary by company, we have all witnessed past downturns leading to M&A, partnerships, portfolio simplification, operational excellence efficiencies and new capabilities.

Moreover, Finance will generally own and even co-own a number of these key transformation programme initiatives, thereby providing a showcase to model the change that leaders want to see. By having a good grasp on finance and a clear understanding of the primary levers/ drivers for value creation, finance should be both a challenger and influencer—holding overly optimistic co-founder/ CEOs and inwardly focused business leaders to accountability. Monthly business reviews with leaders in all functions, examining the factual data of activities and proposals (SPIRIT methodology) will strengthen the right arm of the company (and the PE/ VC investor) on strategic questions as well as on financial results and crucial decisions.

If finance leaders can master these areas described above, I am confident it will improve the odds of success quite considerably².

For further reading on how to undertake a successful IPO, please refer to my earlier article: “Key ingredients for a successful Initial Public Offering” by clicking here.

Dee Singh Kothari is a senior partner in Kothari Partners

© & ¹ Ideas expressed and/ or methodologies in this article are solely of the authors. The author nor Kothari Partner’s accept any liability for the incorrect application of these ideas either used by companies, employees or other individuals alike. ² At Kothari Partners, we have worked with various UK and overseas listed and PE/ VC backed clients across various industries to consider how their business and finance services can bring them both cost reductions and performance improvement. Our approach is to help our clients understand their current situation, identify the value and decide on the scope, vision and set of strategies for what they could achieve for their business. We help plan their implementation and support them and deliver the solution/ change needed, so it is properly and permanently embedded in their organisation. We aim to help past and future clients by delivering high-quality work to their organisation, generate real efficiencies and free up time to support better business decisions.

For a confidential discussion please free to contact us, via our corporate website: https://www.KothariPartners.com