Natural Entrepreneur: Financial Lessons for CEO's: 1,2,3

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Financial Lessons for CEO's: 1,2,3

More on the top ten lessons for CEO's and business owners

by Helen Dutton, A vision of Your Own, LLC, Weare, NH

Last month, I outlined my Top 10 List of what non-financial CEO’s and business owners need to know about finance. Let’s explain a few of these in more detail.

1. Do it right the first time. It is essential to maintain your financial records from the very beginning. This means recording all income and expenditures in near real time and in accordance with proper accounting practices. Always believe that a very lucrative acquisition is waiting for you, right after a thorough due diligence on your books.

Consider the following example. Accounting standards require that costs incurred to develop a computer software product be expensed as research and development until technological feasibility has been established for the product. Thereafter, all software production costs shall be capitalized and recorded on the balance sheet as an asset. A Massachusetts-based software company I was once with was so profitable, and so conservative, that we did not capitalize any software development costs. Ever. Instead, we expensed all software development costs immediately. At the time, we thought this made our balance sheet look clean, as we had no “soft” assets on the books. Our accounting firm grumbled about it but left it as is.

When we started working on IPO documents, it became clear that this policy would have to change. When the IPO plans were diverted to a merger, we were faced with the task of restating several years’ worth of financial statements and paying the subsequent audit fees. Valuable time, energy, and money were used to review financial and engineering records, documenting when the products were technologically feasible and allocating the costs by product. I believe that this extra work did not add value in any form and depleted our energy, already in short supply as the “acquired” company. The merger was still extremely lucrative, but I can only imagine what might have been different if we had done it “right” the first time.

In another example, there was a small company in New Hampshire where the CEO was primarily concerned with his top line - revenue, and the bottom line – net income, and that’s about it. It is hard to blame him – he had a lot on his plate, as do all CEO's, and understanding where expenditures were recorded was not a priority. If the bank was happy, well, that was enough for him. When I set to work reviewing their accounting records, I gained a clear understanding of the phrase “creative accounting”! It took a month or so, but the financial statements showed a different story once all the corrections were made. As you might imagine, the banks were furious and the CEO was in a panic to generate sales that would change the financial outlook. Luckily, the banks stuck with us, and we were able to correct for the shortfalls and improve the financial picture over time.

2. Know your exit strategy from the beginning. If you expect to liquidate your business after years of pulling out cash, then plan your business to be extremely cash rich. If you think the best deal is for you to be acquired, think of possible suitors and attract them. While execution of your exit strategy may not work out exactly as planned, knowing where you are headed can mean all the difference.

Imagine getting in your car, packed and ready to go, and pulling out a map. One problem – you haven’t decided where you want to go! What map would you get out? What highway would you get on? How would you know to go North or South? If you don’t know where you are headed, what would you have packed? What gear would you need? Who would you need to help you along the way?

The same is true with your business. If you don’t know where it is headed, how do you know what strategy will best get you there? A plan doesn’t mean that you are wedded to it; it only means that at this point in time this is what you want to happen. Again, think of a trip. While you may be headed south to Florida it does not mean you cannot stop somewhere along the way. Perhaps after reaching North Carolina you may decide that is it far enough, warm enough. Apply that to your business: maybe you want to create a service company with offices worldwide. Along the way you take a couple of detours and your business develops into an organization perfect for franchising. Would you walk away from this opportunity because it wasn’t in your plan? Of course not – you would consider it as you would any opportunity. It is my opinion, that a clear direction best prepares you for other potential opportunities attractive to you.

I recall one client for whom I assisted in writing a business plan with the intent to seek funding. When asked why he started company, he responded predictably by saying “Because I have a great product.” It has been my experience, that while entrepreneurs often think this way, it is never the real reason for why businesses get started. A product may be the vehicle to one’s goal, but I have never seen it be THE goal. When I pressed further, he finally said, “ “Okay, okay – I’ve always wanted to be the president of a publicly-held company.” That goal required a focus of going public quickly, having a very strong executive team behind him, and developing a role in which he could step to shortly after the company went public.

A friend of mine is the sole proprietor of a software company whose product provides a much needed feature within a software application marketed by an industry leader. When I asked him about his exit strategy he saw two possible outcomes: first, that the industry leader would acquire him; second and, probable outcome, that the need would expire due to competition by the leader and the niche would expire along with it. My friend does not want employees nor does he not count on a large influx of cash from a business sale. Instead, his strategy is to keep overhead at a minimum and product delivery streamlined, which provides for a very high net income and no debt. Since cash levels are high he can pull out high levels of cash now and build his nest egg along the way.

There is also the notion that announcing your intentions to the world (regardless of whether that means telling your business partners or your dog), will help make it so. There is some truth to this. If your intentions, desires, or goals are fuzzy, very likely your results will be as well. Planning your exit strategy early does not remove alternatives. Rather, it enhances your possibilities.

3. Look at your financials the way a publicly held company analyzes its statements. Review your financials on a quarter-to-quarter basis and year-over-year looking for trends and consistency. When confronted with critical financial questions, this analysis will help in making the smartest long-term decisions, and avoid those with the greatest impact on your short-term numbers. Do not necessarily look for the biggest short-term gain, at the expense of the bigger financial picture.

An early stage software company I was once with was a venture capitalist’s dream: rapidly growing, highly profitable, and clearly headed for an initial public offering. We began the IPO process but in the process became acquired by a publicly held company instead. I recall summarizing the company financials into quarterly information. While we had been extremely profitable, the quarterly reports revealed huge fluctuations by quarter and year over year. In one year our first quarter was strong, the next year the first quarter was weak. When any given year was highly profitable, the profits were skewed from one quarter to the next. This negatively impacted the publicly held acquirer’s financial statements. If I could do it again, I would have made several adjustment to better track and correct for these fluctuations, including:

Our fiscal year end was July 31. I would have changed the company’s year end to either December 31 or a date coinciding with a quarter end for a December 31 year end; i.e., March 31, June 30, or September 30. If there is a standard year-end within your industry, it is recommended that you adopt it.

It would have been beneficial to monitor our financial statements by quarter and by product segment and compare the financials year to year, looking for fluctuations. I would have asked, “If I were an investor, would I choose to invest in this company?” We were so busy celebrating how much we had grown and how huge the profits were that we did not stop to look at the fluctuations. Having large profits and high sales volumes is fun and exciting in the short term, but the pace may not have made the most sense when viewed in the long term.

Make the best decision for today, but always keep one eye on the future. Remember, an investor or acquirer may be right around the corner.

Helen Dutton is a national business coach for fast growing and entrepreneurial businesses and principal of A Vision of Your Own, LLC in Weare, NH. She can be reached at (603)529-2345 or Helen@avisionofyourown.com. Also, visit www.avisionofyourown.com

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