Any new business model must include sources of revenue, costs, as well as key metrics for measuring success. Here's how we modeled our potential new venture.
The leadership team at Avondale has been discussing a potential new venture around private equity (PE) investing. We've reached the point where we need to do some serious number-crunching to validate the venture's prospects.
Our goal was to scope out this new business model in 20 minutes, because we do not want to waste time on something that absorbs resources but creates no value. Ash Maurya suggests in his book Running Lean that by quickly articulating our business model, we can debate it amongst ourselves, agree on a path forward, then test and iterate it--all with limited investment.
Perhaps the most straightforward part of the business model is to describe our sources of revenue and costs. We want to help investors dissatisfied with the traditional PE model link up with businesses that want to grow but require capital and management transformation. Such a business would provide three principal sources of revenue:
Deal execution fees: Fees received when we close the acquisition of a new portfolio company.
Ongoing management fees: Fees received annually from each portfolio company for managing the company.
Carry equity: A fixed percentage of the equity gains when a portfolio company is later sold or recapitalized.
Our costs include supporting the deal team as well as the team that manages each portfolio company. Our goal is for the deal execution and management fees to more or less offset each of those costs, respectively.
As a result, our profits will come entirely in the form of carry equity. If we do not create value in our portfolio companies, then we do not get paid; it is as simple as that. Our incentives are thus very well aligned with our investors; if they do not earn a profit, we do not earn a profit.
Like many sales organizations, our deal team has a marketing/sales funnel. We can estimate the number of opportunities we need to investigate in order to create a successful deal. The funnel might look like this:
A. 100 acquisition candidates in an attractive industry, which lead to ...
B. 25 quality acquisition opportunities, which lead to ...
C. Seven acquisition candidates where we will submit an Indication Of Interest (IOI), which will lead to ...
D. Two acquisition candidates where we will submit a Letter Of Intent (LOI), which will lead to ...
E. One successful acquisition.
Based on this estimated performance, we can build a deal team that sources a target number of candidates in each attractive industry. If the deal team falls short of our [A] or [B] targets in the next 1-2 quarters, we are likely to fall short of our [C], [D] and [E] targets later in the coming year.
Thus, by having quarterly targets in every part of the funnel, we can quickly identify where we are falling short and address performance issues before they cascade into an overall failure of the program.
We find these types of metrics invaluable throughout our business. The old adage, "you cannot manage what you cannot measure" certainly resonates with us, so we put a lot of energy into agreeing on and tracking metrics across the business. At any point in time, we have a snapshot of our business and can see, for each of our value drivers, exactly where we are on track or underperforming. This level of insight will be critical in pursuing this new venture.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark