Entrepreneurship: Behind the Numbers
February 08, 2021
John Pennett, Partner-in-Charge of EisnerAmper’s National Technology and Life Sciences Practice, talks about the ingredients for successful entrepreneurship—from early to later-stage enterprises—with “Behind the Numbers” host and senior director at CFGI Dave Bookbinder. Gain more insight for your entrepreneurship journey and learn how EisnerAmper can help at eisneramper.com/tech.
DB:My pleasure. Why don't you tell the audience a little bit about yourself? And then we'll jump into the conversation.
JP:Sure, sure. I've been in the public accounting business for my entire career, about 35 years. Started at one firm and have been at EisnerAmper now for about 17 years. I head our technology and life sciences practice for the firm as a whole, so I have responsibilities for all of our offices around the country and all the services that we offer from early stage outsourced accounting services and tax, to audits and IPOs, and M&A transactions, and kind of everything in between, so it's fun watching the practice grow and watching entrepreneurs thrive through the process.
DB:Right. And you're in charge of, excuse me, life sciences and technology. But I thought for the purposes of this program, maybe rather than divide up by industry because there's probably some overlap in the way that businesses conduct themselves, to talk about it in terms of the stage of development. So let's start with the early stage entities if we could first. With regard to early stage innovation, what are you seeing most frequently these days? How are companies differentiating themselves and being innovative?
JP:So entrepreneurship as a category has obviously been super popular. It's one of the fastest growing university programs across the world. And so people are really looking to kind of have their own innovation and create their own way in life, I think. So you're seeing that in technology, all different types of things from the communications, payments, eCommerce, just connected patients, connected with doctors, kind of all across the spectrum. I think a lot of the challenge that entrepreneurs have in that regard is to try to find something that's truly disruptive and truly different because a lot of stuff is just slightly different than something else that's out there; the big challenge is to get something that's truly different. Those are the ones that are being successful. But I don't think anybody wants to work for the man anymore, so everybody would rather be an entrepreneur.
DB:Yeah. So everybody probably thinks that their thing is the greatest new thing. So how do we determine, or how do you determine, what really is that thing that really will differentiate them, and not just an awesome idea?
JP:One of the questions I always ask, and I see angel investors ask—I also do a little bit of angel investing myself through Mid-Atlantic Bio Angels—is to describe your competition. And if you hear the answer, “We have no competition,” it's almost a complete shutdown because everything has competition. It may not even be from a source that you're thinking of. It may not even be something using technology. It could be something totally outside that realm, but there's competition everywhere. So I think identifying who your competition is and what makes you different from that is, I think, really important.
DB:Yeah. Yeah, for sure. It's funny, in my world in valuation consulting, a lot of times as we're working with clients, and we ask them: Who are their publicly traded peers, their companies that they might aspire to be when they grow up, if you will, if they're earlier stage? And more often than not, we hear that same story. We're unique. There's really nobody who's exactly like us.
JP: Right, right. Yeah. There's somebody who's very close, and there's somebody who's probably taking the same path that you are, and is probably even farther ahead somewhere in the world, so entrepreneurship is now a global phenomenon for sure. There are smart people everywhere, and I think that's going to continue. So I think you have to really be aware of the landscape around you to try to figure out how to differentiate yourself. And that causes a lot of companies to have to pivot as they go through that analysis. And they see maybe we're not quite so special, or there are other people who may be farther ahead than we are. And it causes them to pivot into a slightly different direction. And I think that's a sign of a good entrepreneur to be aware of your surroundings and adjust to try to attack a market that you could succeed in.
DB:Yeah, for sure. It's also a good sign of a game day coach in the NFL.
DB: Adjust on the fly.
DB:You allude to challenges in that pivoting kind of an idea. And certainly for early stage companies, there's a whole boatload of challenges. Everything is a challenge as you're doing it for the first time. Building a team, attracting financing, the whole host of them. What are the ones that you see right now that are the largest challenges for entrepreneurs?
JP:So one of the challenges definitely is building a team. So we see so many organizations at the start kind of really going through bootstrapping as their financing strategy, so they really don't have a lot of money. So as a result, they're trying to attract a team, getting some consultants, getting some people to do things for stock options or other things like that. But truly building a team of believers is a really hard thing to do, but I think it's really critical. So I think we encourage entrepreneurs to find advisors, create an advisory board, even if they're kind of unpaid positions. Maybe you can give them a little bit of equity to help them get on board to build a team of people, because ultimately at the end of the day, you think of what an investor is going to look at, the team has to be able to execute the technology, so you always invest in the team first.
So I think again, we're finding teams from around the world. So if they can find some consultants to help work on their development side overseas, certainly that's a very popular thing to do. You pay them as you can at the very, very beginning, until you can kind of formalize those arrangements, and then you take care of them down the road. So I think that certainly is one of the challenges, is finding the team and finding some advisors. I think the advisors help to build credibility for the organization because, if ultimately you're going to try to raise money, there has to be a belief that this team has enough horsepower, enough execution, skills, and they could actually complete the project.
DB: Yeah, and deliver on the promise.
DB:Yeah. So a lot of times, when you hear about funding, entrepreneurs look to Shark Tank as kind of the model for how to think about attracting early stage investing. There's a lot of great things on Shark Tank, for sure. But when you start to talk about dilution, and giving up equity in your business, how important is that? And how should owners and entrepreneurs be thinking about that?
JP:It sort of reminds me of a story of a client of ours, who was on Shark Tank. And she had gone through the process, and at the end, she said, "At the end of the day, you realize it's a TV show. It's really not a venture capital pitch day. It's a TV show." So they wanted to put together a particular story. They had her kind of reset how the company was put together a little bit to make the story a little bit more interesting for TV. And even though she "received funding" from the show, she actually never did receive any funding because in due diligence, they actually decided not to invest. But it's a TV show, so it was cool, and it's a nice piece that they have and all that, but it just sort of ... It never worked out from the financing perspective.
But to get to your question on sort of dilution, ultimately dilution is inevitable. I think companies who do try to hang onto too much ownership and not give enough opportunity for investors to make money I think is really short sighted. Investors are doing this to make money, not to help you achieve your goal, but for them to make money, so it has to be a win-win for everybody. You want to be smart about it, so I kind of believe in the concept of raising enough money to accomplish the objective at hand, meet the next milestone, the critical milestone, which we can then use as a value inflection point to jump to the next level of valuation. So I think you have to be really smart about it. And from my perspective, when I see a company talking about trying to raise money, to me, if they don't have a really clear plan as to how much money they need and what they're going to be accomplishing with that amount of money, then it's probably not an investible company. You have to have real crystal clarity what it's going to take to achieve that goal.
DB:Yeah. John, for folks who are watching and listening and want to learn more about you or how to work with you, what's the best way for them to reach you?
JP:So you can certainly reach me through the EisnerAmper website. If you go to the professionals page there, you can find the link to my email. Or if you go to our technology or life sciences landing page, you can contact me through that as well. Certainly, I'm on LinkedIn and Twitter as well.
DB: Yep, for sure. So you talk about Shark Tank, and yes, it's a TV show. But somewhere in the investment world, whether it's TV or otherwise, entrepreneurs have to catch the attention of an investor. They've got to present something that's going to make them not only just different but investible. What's important to investors?
JP:So it's sort of interesting, so this past week was the traditional JP Morgan Healthcare Conference week in San Francisco. Of course, it was all virtualized this year. And there's probably a half a dozen concurrent conferences that go on the same week in San Francisco. Again, this year all virtual. And I participated in a number of those conferences, some in my role as an EisnerAmper employee, and some as a role from Mid Atlantic Bio Angels. And so I sat through a couple dozen 20 or 30 minute presentations. At the end of the week, I can't remember what any of them did. It's just too many. But I took enough notes, I didn't take a lot of notes, but I took enough notes to basically give them a smiley face, a frowny face, or a neutral face. And that's really for the follow-up.
So it's the first couple minutes of the discussion that I make that decision. So the rest of the 20 minutes, I'm listening, but I'm not really listening. I'm not really understanding it. It's just too much volume. But it's really that first couple of moments that captures the attention, so it's sort of the quality of the team. It's the opportunity, and it's the TAM, the total addressable market. So are you trying to solve a big problem? Does this look like a unique opportunity? And do I think this team is credible?
If I can kind of get through that and I kind of put the smiley face next to that company, then that's somebody I want to follow up with. If I don't get that in the first couple minutes, it's really hard to get my attention back. And I think a lot of investors are sort of that same way, really short attention span. But you have to have something that's a really unique item, a nice, big addressable market, so that TAM is really important because you want to try to be solving a big problem, so that an investor can have the opportunity to make a big return.
DB:Yeah. So let's talk about total addressable market just for a minute here. From the valuation lens, working with earlier stage companies who, when we asked them for a forecast, a lot of times they'll shortcut it, and they'll say something like, "Well, the total addressable market is X. And if we can just get 1% of that addressable market," that's a little bit lazy. It's a little bit of a cop out. Not a whole lot of rigor in that either.
DB:So in the just five minutes or so that we have left in this segment, how would you talk about folks who are thinking about their streamlined forecast as a so-called percentage of total addressable market?
JP:Yeah. I think that's a really big challenge, and we'll see companies go and they'll put together marketing studies, or have marketing studies commissioned to try to understand who is currently addressing that market and who has what kind of market share. And then they try to figure out what pieces they can pull away from that as a result of being able to launch their product. So I kind of like the bottoms up approach of saying, "How do I get to that process?" One of the things I think that's really had about putting together those projections is thinking about the timeframe to hire a salesperson, train a salesperson, get them to make some contacts, to nurture those contacts, and then turn that into revenue. That's a long time. So when you see companies say, "Well, I'm going to hire 20 salespeople, and that's going to result in us being able to attract and grow the market share by the end of this year," you kind of think of that and say, "It doesn't sound like a credible story."
It's really hard to find people. It's hard to get them to leave where they are and to be productive at your shop. So it takes a long time to get there. But I think going from the bottom up is really important. I think one of the things that we see in a diligence perspective quite often is an investor will say, or a private equity group who's maybe looking at a technology company will say, "I think I can drive sales through this organization because of other contacts that we have, other companies we have. We can piece things together and we can drive business through this organization." And then comes another challenge, which is really understanding what is the fully burdened cost to deliver those services? So a lot of times, companies aren't really thinking about all the costs it takes to deliver the services efficiently and effectively. And as a result, gross profit as an accounting term kind of gets lost in the shuffle, but ultimately becomes a really important measure to try to figure out. If we can drive volume to your business, how much money can we make on it?
DB:Yeah. John, I'm going to try and do one more, sneak one in, lightning round, 60 seconds. Best tips for entrepreneurs to save some headaches down the road.
JP:Build a great team. Put your ownership in place very quick, very early. So if you want to have some early partners, get them signed up early. Document that clearly. Keep good records on that. Kind of build a good culture. Determine the culture that you want to have for the organization and stick to that culture throughout.
DB:Yeah. Great stuff. And each one of those is another great segment for our next Behind the Numbers show, so hopefully you'll come back and talk more about those. But we're going to take a quick commercial break here. John, you sit tight. You watching and listening, don't go anywhere. We'll be right back on Behind the Numbers after this quick break.
DB:And welcome back to Behind the Numbers. I'm DB, and today we're talking with JP from EisnerAmper. John, we had a good chat in the first segment where we were talking about early stage enterprises. Now we're going to shift to the later stage and going from that early stage into later stages of development. So let's first talk about the scaling. How do we get there? So from entrepreneurs who are starting out with these smaller businesses, what's the key to success in scaling to get to that next level?
JP:So there's a couple things I think that are really important. So typically, companies will have maybe some pilot programs that they might run with some organizations, where they'll put their technology in place with those organizations and get some feedback, maybe tweak things a little bit. But the goal would be to sort of get that as a reference-able account. So if you can kind of get that account, work out the bugs, get them to renew and sign on again, and be a reference-able account to attract other companies, that's really important. One of the things that you think about is: What are those key metrics to scale?
So certainly in the technology world, churn is really important. The more your customers are churning, obviously that's a worse sign. Right? So you want companies to sign up, like the product, renew the product for the next year, for the next cycle, add more seats to the license, add more users to the technology. So I think getting through those early learnings, fixing the mistakes, improving the product on a continuous basis, I think that's really important. You're seeing a lot of technology companies now having dedicated customer success teams. So their job is to make sure that they're talking to the customer on a routine basis. Is the technology doing what it's supposed to be doing? Is it achieving your goals? What is it not achieving? Is there something we could add to it? And then kind of continuously refine the product, so the product development is a continuous process along those ways. And then just really working those channels to see, “How do we grow that?” How do we add companies to the top of the funnel and kind of work them down into customers down the way?
DB:Yeah. So in the early stage, building the team was important. Right? The core, if you will. So now as we're starting to grow and expand and scale our business, we presumably need to add more people, more employees. So what's your advice for folks in building the larger team after assembling the core?
JP:So I think it still gets back a little bit to culture, so you need to have people who are coming from the mindset of the same culture that you're trying to build. Or companies, once they kind of establish that identity and that culture, I think it's really important to stay true to that. I think where you deviate away from that, I think a lot of problems happen. So you have to try to find people who are hungry and looking at things the same way you are, want to grow the business, want to be part of the success of the organization, so we're certainly seeing companies in the technology world helping to incentivize people by using stock options and things like that to give them an ownership mindset and an ownership mentality. And I think that's really important, not only from a compensation and ultimately creating value, but really kind of creating an “all in” concept, so we're all in on this.
DB:Yeah. The concept of internationalization, is that an important thing for the scaling businesses? And can it simply be achieved by having an online presence? As we've now learned during this global pandemic, that you don't necessarily need to be there to do business there.
JP:Well, that's certainly correct. You don't need to be there. Myself, I haven't left the house very much in the last nine months or so. But I think internationalization is more than just having people on the ground or salespeople visiting customers. It's being part of that culture as well. So we're certainly seeing on the technology side, development is being done around the world. So there are development shops that are set up. There might be software developers in Eastern Europe and India. In the biotech world, you'll see China, India, many other places, where the work is being done. And so you have a dedicated team of scientists with the skillsets you need because the skillsets are everywhere now. And I think on the customer side, you need to have sort of that touchpoint. So it's really hard to do everything remote.
You need to have some partners. So whether you use channel partners to help you go to market, you use a third party to help promote your products in a particular marketplace, or you have some local salespeople or country directors to help drive that side of the business. I still think that's important that you have that presence. Certainly, we're seeing in our business most of our technology clients, almost all of them have an internationalization element to their business, whether it's on the development side or the sales side. It's just critical to grow the business.
DB:Yeah. Let's talk a little bit about funding. So for the early stage guys, early stage companies, we talked about having a unique differentiator and a large addressable market. What attracts investors into these companies now as they start to mature?
JP: So once you get to the point where you've got to launch products, now you're starting to think about some of those scaling metrics, so you're looking at things like churn. You're looking at things like growth in the marketplace, the number of users increasing, the revenue per user, the revenue per license, things like that on the software side of things. So you're looking at it ultimately as: Can I sell more products to a growing customer base? So can I increase my revenue per customer? And can I grow that overall customer base? Can I add on other products and things like that? So as you start to scale, you start to think about new product development, products I could acquire. Can I put things together to create a more holistic offering to our customers so that I have a more complete package that would be more attractive to them?
So those are the types of things that you think about as you're growing that business. What's the cash flow requirements going to be to get there? So if I have to continue to invest in product development and sales and marketing, how many rounds of financing do I need to invest in the company? So you'll see companies raising their series B, series C, series D round. At some point, you have to actually become profitable. So we always think about: What is that point where you hit the breakeven level from a cash flow perspective, and you no longer need to go back to your venture capital for more money?
DB:Yeah, that path to profitability, for sure. John, for folks who want to learn more about you or connect with you, how can they do that?
JP:So the best way to reach me is through the EisnerAmper website. And if you go to the professionals, you can find my bio there. Or if you go to the technology and life sciences landing page, you can find my contact information there.
DB: Yeah. So John, what are some of the things that folks driving these scaling businesses need to watch out for? What are the risks that they're taking on? And how can you save them some heartburn from what you've seen from others take on?
JP: So you think of a couple of war stories of things that didn't work so well. As an example, we had a client who had issued stock options to almost all of their employees, probably 100 employees. They're going through a transaction, an M&A transaction with a public entity, so they have to have an audit done for the first time. And the stock option accounting and record keeping that they had done was sort of like a where's Waldo, so the employee said, "I had 500 options at $1." The corporate record said, "You had 300 at $2." The board approved 600 at 30 cents, just a complete where's Waldo of what actually happened.
So keeping really good records, memorializing all your transactions, is really important if you have founders and really early key employees that if you're going to give them equity, give it to them really early. Document it and put it in your Drop Box or whatever storage system you're using because if you don't, the ramifications, like in the example of that case, they had to go back to longtime employees and say, "We're taking back your options and giving you a much less attractive option, because otherwise, we're going to trip really bad tax issues and things like that."
DB:That doesn't end well.
JP: That doesn't end well, so it created a lot of, instead of goodwill, it created a lot of ill will.
JP: So that's for sure. You think about other things just in terms of keeping good track of compliance. So in a software world, many, many, many companies are somewhere behind on sales tax. So it's a super complicated area, people like to bury their head in the sand on that topic because it's really hard and confusing and takes a lot of effort, so I think that's an example of another thing where you want to try to get ahead of that early on. And just having good governance, good record keeping, good contacts in terms of library type functions with your sales arrangements and all those types of things.
DB: Yeah. John, we probably have 90 seconds or so to go here, so I'm going to be really unfair and ask you to condense a response, but the endgame ultimately is some form of exit, whether it's an IPO, whether it's a sale, or now SPAC is a popular way of getting out there into the market. What are you seeing? And what are your recommendations for folks who are contemplating an exit?
JP: So come up with a reasonable valuation, have an objective that makes sense, that way everybody can win. In the public marketplace, super hot as everybody knows right now—biotech, large technology companies—they've created really big marketplaces, so I think there's some great opportunities there. But you've got to put together a great team, a great story, be able to meet your objectives and meet the milestones that you're promising people.
DB:Yep. Awesome. John, thank you so much for joining us today on Behind the Numbers.
JP:My pleasure. Thanks for having me, Dave.
DB:It's a pleasure here. So thank you for watching and listening Behind the Numbers. I'm DB, and today we've been talking with JP, the Partner-in-Charge of the Technology and Life Sciences Practice at EisnerAmper. If you'd like to connect with me, you can find me on LinkedIn, Facebook, and Twitter. Be sure to hit the subscribe button so you can stay in touch with us and know all that we're up to. Thanks again, everybody. Until next time, take care.