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Assessing Your Company's Potential

"Know yourself and know the enemy . . . and you will know the outcome of the battle before it starts."

- Tsun Zsu

The iterative process of assessing and reassessing the fit among the cen­tral driving forces in the creation of a new venture are vital to the growth of a business. Of utmost importance when talking about the growth potential of a small business is the fit of the lead entrepreneur and the management team with an opportunity. Good opportunities are both desirable to and attainable by those on the team using available resources.

In order to understand how the entrepreneurial vision relates to the analytical framework, it may be useful to look at an opportunity as a three-dimensional relief map with its valleys, mountains, and so on, all represented. Each opportunity has three or four critical factors (e.g., proprietary license, patented innovation, sole distribution rights, an all-star management team, breakthrough technology). These elements pop out at the observer; they indicate huge possibilities where others might see obstacles. Thus, it is easy to see why thousands of exceptional opportunities will fit with a wide variety of entrepreneurs but not fall neatly into the framework outlined in Exhibit 2.1.

Exhibit 2.1	Criteria for Evaluating Venture Opportunities
	Attractiveness
Criteria	Highest Potential	Lowest Potential

Industry and Market

Market:

Customers User benefits Value added Product life

Market structure

Market size

Growth rate

Market capacity

Market share attainable (Year 5)

Cost Structure

Changes way people live and work

Market driven; identified; recurring

revenue niche

Reachable; purchase orders

Less than one-year payback

High; advance payments

Durable

Imperfect, fragmented competition or emerging industry

$100+ million to $1 billion sales potential

Growth at 30-50% or more

At or near full capacity

20% or more; leader

Low-cost provider; cost advantages

Incremental improvement only Unfocused; one-time revenue

Loyal to others or unreachable Three years plus payback Low; minimal impact on market Perishable

Highly concentrated or mature or declining industry

Unknown, less than $20 million or multibillion sales

Contracting or less than 10%

Under capacity

Less than 5%

Declining cost

Favorable; sustainable; 20-30% or more of sales Less than 10% of sales Moderate to high +15% to +20% Less than 10% Low/sales $ High Low, incremental requirements High requirements Low requirements High requirements Exceeding 40% and durable Under 20% High; greater than 10%; durable Low Less than two years; breakeven not creeping Greater than four years; breakeven creeping up

Economics

Time to breakeven/positive cash flow

ROI potential

Capital requirement

Internal rate of return potential

Free cash flow characteristics: Sales growth Asset intensity Spontaneous working capital R&D/capital expenditures Gross margins After-tax profits

Time to break-even profit and loss

Harvest Issues

Value-added potential

Valuation multiples and comparables

Less than \'A-2 years 25% or more per year Low to moderate; fundable 25% or more per year

High strategic value

Price/earnings = 20 + x$; 8-10

EBIT 1.5-2 + Xj, revenue: free cash flow 8-10 + x<

More than 4 years Less than 15-20% Very high; unfundable Less than 15% per year

Low strategic value

Price/earnings <5x, EBIT <3~4x;

revenue ^.4

(continued)

Exhibit 2.1 Criteria for Evaluating Venture Opportunities (continued)

Criteria

Highest Potential

Lowest Potential

Exit mechanism and strategy Capital market content

Competitive Advantage Issues

Fixed and variable costs

Control over costs, prices, and distribution

Barriers to entry

Proprietary protection Response/lead time Legal, contractual advantage Contracts and networks Key people

Management Team

Entrepreneurial team

Industry and technical experience

Integrity

Intellectual honesty

Present or envisioned options

Favorable valuations, timing, capital available; realizable liquidity

Lowest; high operating leverage Moderate to strong

Have or can gain Competition slow or napping Proprietary or exclusivity Wei I-developed; accessible Top talent; an A team

All-star combination; free agents Top of the field; super track record Highest standards Know what they do not know

Undefined; illiquid investment Unfavorable; credit crunch

Highest Weak

None

Unable to gain edge

None

Crude; limited

B or C team

Weak or solo entrepreneur

Underdeveloped

Questionable

Do not want to know what they do not know

Fatal-Flaw Issue

Nonexistent

One or more

Personal Criteria

Goals and fit

Upside/downside issues Opportunity costs Desirability Risk/reward tolerance Stress tolerance

Strategic Differentiation

Degree of fit

Team

Service management

Timing

Technology

Flexibility

Opportunity orientation

Pricing

Distribution channels

Room for error

Getting what you want, but wanting what you get

Attainable success/limited risks

Acceptable cuts in salary, etc.

Fits with lifestyle

Calculated risk; low risk/reward ratio

Thrives under pressure

High

Best in class; excellent free agents

Superior service concept

Rowing with the tide

Groundbreaking; one of a kind

Able to adapt; commit and decommit quickly

Always searching for opportunities

At or near leader

Accessible; networks in place

Forgiving strategy

Surprises, as in The Crying Game

Linear; on same continuum Comfortable with status quo Simply pursuing big money Risk averse or gambler Cracks under pressure

Low

B team; no free agents

Perceived as unimportant

Rowing against the tide

Many substitutes or competitors

Slow; stubborn

Operating in a vacuum; napping

Undercut competitor; low prices

Unknown; inaccessible

Unforgiving, rigid strategy

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