Back to the business of cash flows

- in Blog | 5 min read

Potential clients often claim they want to work with me since I know what investors want. Had I ever met a standard situation or standard investor I would not object. Truth is, just about every case I ever dealt with required quite a dive into company history, markets and data to truly appreciate it (plus the energy to make all of this transparent and interesting to the usually somewhat detached average private equity analyst). By the same token I am forced to admit that any party who ever bought or invested into the companies I advised qualified as “investor”, yes. And yet, how different the motivations and strategies, not to mention the personalities of course.

But there must be a reason clients put it that way. My guess is that all those buzzwords that float around and supposedly express lasting principles are not as enlightening as rather confusing. Take “scalability” – meant to convey one of the most important investment criteria: the potential of a given business (model) to prosper exponentially, due to a widening gap between input and output factors (not the most elegant definition, but you get the point).

However, the term as such does more to hint at the founding idea of an early stage investor than to define any investment criteria. How scalable is scalable enough, how on earth should an entrepreneur reconcile such requirement with the need of running his business solidly and did such terms not do more to skew countless Excel FCSTs (unbelievably, to this day) than to contribute anything valid to any business plan ever?

And then there are concepts in corporate finance that seem to belong to a different age and time – such as cash flows. For the most part I obviously cooperate with German native speakers, so one reason the term comes across as rather exotic is that we lack a smooth German translation. But another may lie in the fact that catchier terminology appears more appropriate for “digital” business models. Well yes, until reality sets in and one finds that raising the next round of capital or selling a company anywhere close to the valuation of the last round is somehow rather hard. So why is that?

Let’s put ourselves in the shoes of an entrepreneur striving to build sustainable company value. Here referring to an entity that sustains him and his employees – and that could at the same time be of interest to investors. What is the one metric that serves him best in managing his business? This obviously also depends on your ecommerce-, b2b saas-, project driven – or whatever it maybe business model. But at the end of the day, what would – and must you as an entrepreneur– always check on?

This is where I still like to bring in Warren Buffet, b.1930 (regardless of what he may or may not have said or done about Bitcoins, not my topic here). Raised in a country and at an age where stock markets were already totally common, just like the many pages in the papers (deserving the name) filled with stock listings. These, or so the myth goes, he looked at, wondering, which stocks to potentially buy – had he had the means (the romance coming from him being a newspaper boy at that time).

So what metric made most sense to him, in these supposedly pre-modern times, without that many data sources and data points to analyze either. Well, cash flows. Why cash flows? Because an asset (stock being an asset class just like the non listed shares of your start up or SME) is considered undervalued (and therefor worth buying) if its price in the capital markets is below the present value (simplified: the sum of) future cash flows (if this has not deterred you already I warmly recommend the more than readable “The Snowball. Warren Buffet and the Business of Life” by Alice Schroeder).

As simple and intuitive as that.  Brought into our world: the VC focuses on Exit cash flow, the PE trusts only the good margins he then wants to extend, the strategic buyer relies on business and profit enhancing synergies. Circumstances  and details may vary, but the basic framework stays absolutely the same.

Now how about you as an entrepreneur? Well, like it or not, cash dominates your life too. We hear and and use the term “burn rate” so often that it sounds almost endearing to us. If you are not sitting on reserves yourself, though, or without a resourceful investor as good business friend your lifeline as entrepreneur is only as long as the invoices you issue cover the bills you need to pay for. You therefor have a burning (forgive the pun) interest in your liquidity status and forecast too.

Thus right of the bat you as an entrepreneur and all those investors out there share a very common understanding of things and little need for fancy terminology and metrics (this said I am a big fan of dashboards but really only to the extent they actually explain processes, making them more transparent – and are logically tied to the top and bottom line of a business).

So what are the factors that apparently separate the motivation and judgements of entrepreneurs and investors anyways? Is it the latter pushing for the eventual company sale?

Only to a small degree. How many entrepreneurs burn with the desire to work unlimited hours for an unlimited number of years to then realize that a natural successor is really not around and suitable management buy in candidates hard to find? On top of which the company, sadly, is not relevant enough in terms of size and market access to be of interest to strategic buyers.

While the timelines may but must not differ –  given the various investment fund structures around – the natural goals of entrepreneurs and investors are more aligned than conventional wisdom dictates (the entrepreneur being an investor too, just of a different sort). And since the goals are close, so should the KPIs.

Maybe the next time you think your own case through for presentation purposes, you keep that in mind,  find your own trade off between parameters that help to explain your business and the essentials, widening the range of candidates to talk to.