Never lie your hockey-stick projections

Entrenotes by Milt Capps Updated 1326

Hockey's in the air, but we're not talking about the Stanley Cup or the FBI's investigation of Predators investor Boots Del Biaggio.

Instead, a note on "hockey sticks," those spurious projections of startup revenues that depict poor-performance in the all-too-verifiable near-term, but incredible rebirth and profits farther out -- usually, three or four quarters out. I had to chuckle this morning while discussing "business valuation" with Chris Lovin, CPA, who's with Brentwood-based LBMC.

He was explaining that valuation experts are often not in the position to render formal opinions on a company's financial-growth projections, per se. Providing an opinion brings with it additional requirements.

However, Lovin said, if in the course of their work management provides a CPA projections that look like "the old hockey stick," they'll often ask questions. The reasons behind such caution, or outright skepticism, are important for startups, particularly those seeking investors. It's widely agreed that, while an hockey-stick projection may be fairly derived and "valid," that initial downward slope is often viewed as a clear signal of current problems.

Potential investors, we've often heard, are less concerned about your projections -- they assume you're going to be proven wrong, no matter what -- and more interested in how you think about those projections and what you plan to do about expenses, your most controllable ingredient. If your hockey stick suggests you're under the delusion that your admin, marketing, technology and other costs are going to remain fixed, they'll probably wonder what you've been smokin'.

The best rule: Never lie about your hockey stick. Also helpful: Regardless of your projections, meet your performance benchmarks. Missing benchmarks leads directly to discounting your revenue projections as much as 60 percent, I've heard. A couple other thoughts spurred by my conversation with Lovin, and relevant for startups: Eventually, your business will face valuation, often due to some change in control (new partners, M&A, sale, etc.).

At that point, you and your team will need to be able differentiate between the proportion of "goodwill" -- let's call that the difference between the price a buyer has agreed to pay for your company, versus the net value of your assets -- that should be assigned to the company, itself, versus that share of goodwill that should be assigned to a key executive, perhaps a founder, who has his or her own following among customers.

Depending on business structure, we're told, this can be an important tax issue for the company and individual owners. It's something I suspect few tech entrepreneurs -- who typically remain deeply involved in their companies, as long as possible -- think about, until it's time to sell.

There are many other issues that deserve attention -- such as valuation of rapidly obsolescent technology and intellectual property. A few years ago, I produced a conference, held at Belmont University and titled, "Understanding Business Valuation." It was for tech companies and attracted great participation. I'm considering doing it again, so please write me with your thoughts on these and other issues. Cheers, Milt Capps