David Jacobson's External Insights

Where is your business going? #4 Raising finance: venture capital or private equity

The Minister for Industry, Tourism and Resources the Hon Ian Macfarlane MP has announced a thorough review into the venture capital (VC) industry in Australia.

Recent takeover activity means that shareholders are looking for new investments.

But how do you match up business owners looking for finance with potential investors?

And why would a company seek investors rather than commercial finance?

There are several types of business financing options available to growing companies.

Assuming the business has got past the startup stage when the founder used up his or her cash reserves (and credit card limits) and the business cash flow is not sufficient to fund further development or expansion then the first option is a commercial loan. But paying off debt can drain a business with limited cash flow. New companies may not even have access to bank loans if they have no operating history and no security for the loan. Mortgaging your home is a serious step you need to carefully consider.

Angel investors are a prime source of early-stage financing. They are usually individual investors often willing to invest where there is too much risk for banks and not enough profit potential for venture capitalists. Angels will invest for a longer time than other investors  --  up to three years or more. They may also invest smaller amounts  --$1 million or less.

Venture capitalists, by contrast, represent managed funds which have stringent investment criteria and generally invest in high-growth companies. Because they need to realise a profit in three to five years, venture capitalists will not consider very new businesses and invest in larger amounts.

Venture capitalists often take an active role on the company's board. Founders will need to accept a potential loss of control in return for the skills that the investors bring to the board table. But both parties must be comfortable with the terms of their agreement and their respective personalities.

According to Paul Allen in the USA:

• Angels fund 30-40 times more companies than VCs, but they do much smaller deals.
• VCs fund 1-3% of the deals they look at
• Angels fund 22% of the deals they seriously consider
• Angels fund 84% of rounds under $250,000
• #1 source of initial funding for startups is entrepreneur's own savings (74%)
• 10-15% of entrepreneurs who pitch at non-profit capital forums raise money
• 40% of entrepreneurs who pitch at venture forum meetings get funding
• Top two criteria for angels to invest in an entrepreneur are 1) enthusiasm of the entrepreneur and 2) trustworthiness of the entrepreneur.
• 94% of angels consider location to be very important in their decision   
• 80% would have made more investments over the past 3 years if they had seen more good plans.

Further Reading

Raising money by a startup

Top Ten List on Pitching VC's

Technology Ventures: From Idea to Enterprise this website includes case studies, short video clips, articles, and PowerPoint slides all focused on the creation and management of technology ventures. This site will continue to evolve with new media and features.

Management Buy out case study

Frank Demmler's site

Venture Capital in Australia

Schedule Games

One of the biggest problems in project planning is working out a schedule when there are so many variables, not the least being that the project scope hasn't been identified yet and you don't know all the tasks you are required to do. Or you are asked to work to a specified completion date even though you are told by the client that it won't be able to meet that date.

At Managing Product Development Johanna Rothman has written a series of 11 posts called Schedule Games that offer a lot of practical insight into managing this issue. And I agree with her, the first 90% of a project is easier than the last 10%. It's best to break tasks down into the smallest unit ("inch pebbles") so that you assess completion of tasks not percentages.

• #1 Schedule Chicken
• #2 90% Done
• #3 Bring Me a Rock
• #4 Hope is Our Most Important Strategy
• #5 Queen of Denial
• #6 Sweep Under the Rug
• #7 Schedule Dream Time or Happy Date
• #8 Pants on Fire
• #9 Schedule == Commitment
• #10 We'll Know where we are when we get There
• #11 The Schedule Tool is always Right
• Acknowledgements

Corporate Social Responsibility: is it overstated?

The adverse publicity caused to James Hardie over the Special Commission of Inquiry into its funding of compensation for asbestos victims recently lead James Hardie Chair Meredith Hellicar to insist that the company had complied with corporate social responsibility (CSR) principles (The Age).

There is currently no law that compels company directors to take social and environmental issues generally into account in making business decisions (except of course if the company would otherwise breach a workplace or OHS law or similar).

The ASX's Corporate Governance Council's Principles of Good Corporate Governance  contain recommendations for listed public companies . Principle 3 encourages boards to recognise responsible and ethical decision making. Principle 10 recognises the community as a non-shareholder stakeholder in companies.

Some companies believe that publicity about commitment to CSR gives them a competitive advantage (see Westpac's 2004 Stakeholder Impact Report, GE's 2005 Citizen Report). Other businesses though  believe their primary focus is their return to  shareholders and legal compliance.

Westpac tries to balance its obligations this way:

There is no doubt that people want us to conduct our business in a way that not only meets our profit imperative, but also fulfils our broader workplace, social and environmental responsibilities. Our aims are simple – to have a society where our business enjoys the confidence, trust and respect of our owners, our customers, and the people who work within it.

Ian Davis in The Economist ("The biggest contract") argues for the need to balance the views  of those who believe, on the one hand, that the “business of business is business” and those who argue that CSR hasn't gone far enough.

Some key quotes:

Large companies need to build social issues into strategy in a way which reflects their actual business importance. They need to articulate business's social contribution and define its ultimate purpose in a way that has more subtlety than “the business of  business is business” worldview and is less defensive than most current approaches. It can help to view the relationship between big business and society in this respect as an implicit “social contract”: Rousseau adapted for the corporate world, you might say. This contract has obligations, opportunities and mutual advantage for both sides...

Big business provides huge and critical contributions to modern society. These are insufficiently articulated, acknowledged or understood. Among these are productivity gains, innovation and research, employment, large-scale investments, human-capital development and organisation. All of these are, and will be, essential for future national and global economic welfare. Big business also provides a vehicle for investment that is likely to be central to the provision of pensions in the ageing.

As reviews of the law of directors' liability continue post-HIH and James Hardie it will be interesting to see how the politicians view the appropriate balance.

Where is your business going? #3 Family businesses

Setting the ground rules for a family business can be more complicated than other businesses because of the emotional issues involved. Family businesses are a large part of the Australian economy but they often fail to deal with the way that  personal relationships affect the business.

In 2004 27% of firms listed on the Australian Stock Exchange were family controlled. It is estimated that the wealth of family business is Australia is A$3.6 trillion.  But, raising concern for succession planning, 33% of small business owners were aged over 50. (Source: Monash University: Family Business and Succession Planning July 2004). The Monash report gives examples of different family business models.

Most small businesses are family-owned, with the obvious large family businesses such as the Smorgon, Pratt and Packer corporations.

Every family business needs to decide what comes first: the family or the business? This will influence every decision that is made about the business from deciding who to employ (and dismiss) to how the business will be financed.

Is family harmony more important than business success? Is the business a short term proposition (develop and sell) or is it to be kept for the long term? If the founders want their children to keep running the business, who will pay for the founders' retirement?

How will the family business be managed?  Who makes the decisions: one person or a family council? Will an external expert manager be employed?

Who owns the business? Is ownership restricted to bloodline descendants? Will it ever go public?

How much are family employees paid? Market value or are they expected to contribute to the capital of the family business by accepting a lower salary? Is everyone paid the same regardless of the effort they make and skills they bring?

Is every family member guaranteed a job? Is every family member expected to work in the business?

Whether it’s the Packer family or two brothers working with dad on a small manufacturing business, eventual control of the family business is a vital issue that every family business must deal with. Who will be the next CEO?

Most family businesses are weak at succession planning. Most do not make it past the first generation, with only three out of ten making it into the second generation.

As the original founders of the family business become older and less involved in the business, the question of who will replace them becomes a major concern for their mature-aged children who are involved within the business. In order for the business to succeed, this issue needs to be carefully considered. There used to be an old saying that “One generation will build an empire, the second generation will fight over it and the third generation will sell the empire and spend what’s left.”

To put the issue into perspective, it's worth reading this article about a son who went into his family's business to please his family, when he really didn't want to.

It's also worth reading about the De Bortoli family and the other families profiled in ABC TV's Dynasties.

The world is flat: technology, globalization and economics

There's been a lot of buzz about Thomas Friedman's new book  "The World is Flat" (ironically not available in Australia yet).

Here's an extract from a New York Times piece by Friedman

Globalization 1.0 (1492 to 1800) shrank the world from a size large to a size medium, and the dynamic force in that era was countries globalizing for resources and imperial conquest. Globalization 2.0 (1800 to 2000) shrank the world from a size medium to a size small, and it was spearheaded by companies globalizing for markets and labor. Globalization 3.0 (which started around 2000) is shrinking the world from a size small to a size tiny and flattening the playing field at the same time. And while the dynamic force in Globalization 1.0 was countries globalizing and the dynamic force in Globalization 2.0 was companies globalizing, the dynamic force in Globalization 3.0 -- the thing that gives it its unique character -- is individuals and small groups globalizing. Individuals must, and can, now ask: where do I fit into the global competition and opportunities of the  day, and how can I, on my own, collaborate with others globally? But Globalization 3.0 not only differs from the previous eras in how it is shrinking and flattening the world and in how it is empowering individuals. It is also different in that Globalization 1.0 and 2.0 were driven primarily by European and American companies and countries. But going forward, this will be less and less true. Globalization 3.0 is not only going to be driven more by individuals but also by a much more diverse -- non-Western, nonwhite -- group of individuals. In Globalization 3.0, you are going to see every color of the human rainbow take part...

when the world is flat, and anyone with smarts, access to Google and a cheap wireless laptop can join the innovation  fray...When the world is flat, you can innovate without having to emigrate.

Friedman describes 10 "flatteners" and the opportunities and challenges that have arisen. And why he calls it a crisis.

See also Doc  Searls' review from a technology angle.

Australia's most trusted professions

Reader's Digest 2005 Trust Survey (Who do you trust Australia?) has come up with this ranking of our most trusted professions:

1. Ambulance officers
2. Firefighters
3. Mothers
4. Nurses
5. Pilots
6. Doctors
7. Pharmacists
8. Fathers
9. Police officers
10. Teachers
11. Childcare providers
12. Bus/train drivers
13. Chiropractors
14. Judges
15. Accountants
16. Priests/ministers
17. Domestic cleaners
18. Bartenders
19. Builders
20. Life coaches
21. Taxi drivers
22. Lawyers
23. Stockbrokers
24. CEOs
25. Mortgage brokers
26. Journalists
27. Psychics
28. Real-estate agents
29. Car salesmen
30. Politicians

Note that lawyers come in at 22, CEO's 24 and mortgage brokers 25.

In the "Most trusted brands category" , financial institutions fared badly with St.George Bank doing the best at 101:

  St. George Bank* (101)

Commonwealth Bank (107)             

ANZ Bank (108)               

Westpac Bank (109)

HSBC Bank         (111)

Aussie    Home Loans  (112)

National Australia Bank   (=114)     

RAMS (=114)               

Macquarie Bank  (116)

Wizard Home Loans    (117)          

Diners Club            (118) 

American Express    (119)

What will you do to improve your customers' trust in you?

APRA releases prudential standards on governance

The Australian Prudential Regulation Authority (APRA) has released draft prudential standards and a discussion paper outlining proposed governance arrangements for authorised deposit‑taking institutions (ADIs), general insurers, life insurers and authorised non-operating holding companies (NOHCs).

The objectives are to ensure that an ADI is well managed, has access to appropriate independent expertise, and gives due consideration to the impact of its decisions on depositors.

The package outlines proposals for boards of APRA‑regulated institutions to:

• meet composition requirements regarding board size, independence of directors and shareholder representation;
• have a majority of independent non-executive directors, with exceptions for certain types of subsidiaries;
• have an independent non-executive director as chairperson of the board;
• establish a Board Audit Committee and a Board Risk Committee;
• have a policy on board renewal;
• ensure their institutions have a dedicated internal audit function; and
• apply independence provisions for external auditors, consistent with the CLERP 9 requirements in the Corporations Act.

APRA Chairman Dr John Laker said that the proposed prudential standards are intended to ensure that APRA-regulated institutions consider key governance principles, based on the ASX Principles of Good Corporate Governance for listed companies, and meet standards of governance that are generally considered good practice.

Comments on the discussion paper and draft prudential standards are invited by 12 August 2005.

Axa: case study in understanding processes

The McKinsey Quarterly has this interview with Axa Insurance's  Claude Brunet.

He  discusses how the company is looking at methods used by manufacturers and other  companies like GE to make Axa more competitive.

A key quote:

The biggest challenge is getting service employees to understand that they use processes. After 30 years of Total Quality Management and other improvement programs, people in manufacturing already have this perspective. They know what a process is, how to analyze it, and how to improve it. This is all new for people in service companies. When we started implementing Six Sigma, early in 2002, we had to get our people to understand existing operations from a process perspective. And when you look at a service company's processes in detail, they may not be as repetitive as the processes and activities at a manufacturing plant.

We're at an early stage, so we can't declare victory yet, but the signs are very promising. We've made some very good progress in improving our procurement processes and our customer retention process.

Service companies like ours can also benefit from other approaches. For instance, manufacturing companies have pioneered ways of examining how long it takes to develop and launch products and then of reducing their cycle time. That's important for service companies too. When you can reduce the time needed to launch products, you can launch more of them than your competitors do.

On innovation he says:

In the property and casualty business there is little room for innovation. The same is true for some savings products and life insurance. If you ask customers to name their insurers, most of them won't know. So it is true, in a way, that companies in our industry have difficulty differentiating themselves or making customers believe that it makes sense to deal with one company rather than another. But there are ways to innovate—maybe not big, breakthrough innovations, but innovative approaches to products and to the way we market them.

Within that context, we are innovating at the margins in products and marketing. In France, for instance, we offer protection for people who don't drive their cars more than 8,000 kilometers a year. We have a competitive protection product in France aimed specifically at young motorcycle drivers. We're also differentiating the marketing offer; for instance, in the United Kingdom we are now launching a protection product comprising several subproducts. The subproducts themselves aren't innovations, but the way we bundle and address them to the target segment is a marketing innovation. We also seek to innovate in the way we serve customers. So there is more than one kind of innovation.

If you want to innovate, you must always do so in a cost-effective, predictable way, and for that you must master your processes. Excellent manufacturers know how to do this. We will too.

Nanotechnology in Australia

I was impressed by a seminar on nanotechnology at the Brisbane Technology Park on Wednesday. It was jointly organized by BTP with Carla Gerbo’s Centre for Business and Industry  and Future Materials.

This technology is no longer science fiction (eg Michael Crichton’s Prey) or an oddity (such as the nanoharp). It has real commercial application.

Professor John Drennan from the University of Queensland Centre for Microscopy and Microanalysis gave us an indication of the size of particles involved: he showed us pictures of the head of a pin magnified 6 million times – we were able to see the atomic structure of bacteria on the pin head.

A nanometer is a billionth of a metre. The diameter of a strand of human hair equals 100,000 nanometres.

Peter Talbot from The Very Small Particle Company is actually manufacturing nano material. He has developed a cost effective process which currently produces 60 tonnes a year. His company has developed its first commercial product.

Rodney Appleby, the senior scientist at Orica Mining Services demonstrated the uses of nanotechnology in his field.

Resources
www.nano.org.au
http://www.nanotechweb.org
Nanotechnology: Brave Goo World? (from Australian Anthill Magazine)

2005 Commonwealth Budget

The Commonwealth Treasurer delivered the 2005-06 Commonwealth Budget on 10 May.

The headlines were the personal tax cuts and the abolition of the superannuation surcharge.

UPDATE 19 May: what if the Budget is not passed by 1 July?

Personal income tax cuts

From 1 July 2005, the 17% tax rate (for incomes between $6,001 and $21,600) will be cut to 15%.

From 1 July 2006, the 42% threshold will rise from the 1 July 2005 threshold of $63,000 to $70,001.

From 1 July 2005, the 47% threshold will increase to $95,001.

From 1 July 2006, the 47% threshold will increase to $125,001.

Current tax thresholds Income range ($)	Tax Rate %	New tax threshold from 1 July 2005 Income Range ($)	Tax Rate %	New tax threshold from 1 July 2006 Income Range ($)	Tax Rate %
0 - 6,000	0	0 - 6,000	0	0 - 6,000	0
6,001 - 21,600	17	6,001 - 21,600	15	6,001 - 21,600	15
21,601 - 58,000	30	21,601 - 63,000	30	21,601 - 70,000	30
58,001 - 70,000	42	63,001 - 95,000	42	70,001 - 125,000	42
70,001 +	47	95,001 +	47	125,001 +	47

See the Treasurer's press release, No 2005/040, 10 May 2005.

UPDATE: Treasury's Tax Cut Calculator

Abolition of the Super Surcharge

The Treasurer announced that the Government will abolish the surcharge payable on individuals’ surchargeable superannuation contributions and relevant termination payments, with effect from the 2005-06 financial year. Individuals who make or receive surchargeable superannuation contributions, or who receive employer termination payments from 1 July 2005, will benefit from this measure. As a result of this measure, from 1 July 2005, the surcharge will no longer apply in respect of superannuation benefits that accrue, contributions made or termination payments received from that date. The surcharge of 12.5% was previously payable by persons whose income exceeded $99,710.

See the Treasurer's press release, No 2005/041, 10 May 2005.

The Budget papers are available for viewing and downloading from the internet at the following alternative sites:

Treasury

Parliament of Australia

National Library of Australia

Department of Finance and Administration

Australian Taxation Office