S1-E2 | Phase 1: Preparation - Building Foundation for Value

Transcript

SPEAKER_01 0:02

Hi, everyone. I'm your host, Joshua Jahani, here in our podcast, The Technical Founder. Today we're doing episode two in our MA Framework series. We're talking about step one, preparation and building the foundation for value. I'm excited to talk about this one. This is probably the most management consulting part of the process. And it means that all the nerds, all the management consulting nerds get uh go into all the details. Uh, Ricardo, how are you doing today? Are you excited about the topic?

SPEAKER_00 0:35

I'm doing very well, very excited, very happy to be with you here again, Dosha.

SPEAKER_01 0:41

So, for our audience, that we're assuming has, you know, some some brief exposure to MA in general, we want to keep them dialed into the deliverables of phase one. So it's the preparation phase. Phase one is where you build everything that you need in the MA process. This includes obviously getting all your financials in order, making sure prior year books are closed. This includes building the confidential information memorandum or abbreviated SIM CIM. And this is essentially a you know 50 to 150 page presentation that goes into everything the buyer needs to know to submit a bid, which we're calling an indication of interest or an IOI. And that's step three in our process. Ricardo, in your experience in these MA frameworks, is there any particular thought processes that you found were most effective in considering the preparation phase?

SPEAKER_00 1:40

Joshua, I think that's a critical point for the audience to understand because the way I see preparation is where professional maturity becomes visible. Not when the buyer arrives, not when negotiation starts, but long before that, when no one is watching at the end of the day. Because preparation is where you decide whether you're serious about value creation or merely hopeful. Preparation forces you to confront uncomfortable realities like is your financial reporting coherent? Are your growth assumptions defensible? Is your customer base stable? Are internal stakeholders aligned? And most companies discover weaknesses due to diligence. Effective companies discover them during preparation.

SPEAKER_01 2:33

I have a question that is somewhat of a uh of an alternative point of view. So one of the things that sellers have to balance, specifically on the sell side now, is letting the MA process consume their whole life. Because particularly for some founders, the amount of money being received at closing is life-changing. They're monetizing a decades, multi-decade lifetime worth of work. And when they get too focused on the preparation, we see it as uh something that can distract them from operating the business and therefore uh you know impact enterprise value in the future. How do you advise technical founders to balance those two elements of like the professionalism of preparation so that they can accomplish all of the benefits you stated, but then also not getting distracted?

SPEAKER_00 3:24

I think that's a there's a clear positioning for people to understand is that preparation, I mean, doesn't mean to build a data room at the end of the day. That's a mechanical view. Preparation is not documentation, it's positioning. It answers one fundamental question. If I were the buyer, what would make me hesitate at the end of the day? And then it resolves those hesitations before they arise. There's a discipline of anticipation. A well-prepared seller doesn't overwhelm buyers with data. They create clarity through structure, and that's exactly what I think you you're referring to. Because if you're becoming too mechanical about it, and you start actually losing the point that a great CIM or confidential information memorandum really does. It organizes reality into something underwritable.

SPEAKER_01 4:21

Yeah, that's great. That's a great way to put it. The underwriting. I think people don't think about the underwriter. Dun dun dun dun. Yeah, right. Almost sounds like a character from a from a fiction movie. But but yeah, it's some guy or girl that is uh going to figure out how to finance the deal with debt pretty much all the time, right? And you know, when you're using debt, you have to pay the debt back. That's how it works in capital markets these days. And, you know, the assets of the business have to be able to support interest payments. There has to be a reasonable path to profitability or some kind of underwritability. And um, you know, lenders can be very narrow in their view of what's underwritable. Uh, we see a lot of sellers hear about underwriters for the first time when they're talking to us. Underwriting is the best way to manage their expectations of cash on close, because in pretty much all cases the cash paid for at close comes from some kind of line of credit that the buyer's using, very rarely does it come through an equity check. And I can see it it reset expectations a lot. We try to do that prior to the official preparation phase for most of our deals.

SPEAKER_00 5:31

Look, I mean, since you mentioned about characters in the movies, I mean, inevitably one thinks about villains and heroes, right? And when it comes to financial preparation, is where the intellectual honesty, the heroes, becomes non-negotiable. One cannot claim scalability if margins are volatile, one cannot claim recurring revenue if churn is rising, one cannot claim operational excellence if working capital swings unpredictably. So effective professionals do not massage the numbers, which is very tempting. Uh not necessarily be moved by disloyal intentions, but try to really improve your thesis behind the deal. But effective professionals need to interrogate the numbers. They ask, what's structurally repeatable here? What's one-off? What's fragile? What's defensive? So this is not pessimism, this is strategic rigor, and rigor builds trust.

SPEAKER_01 6:33

Yeah. The realism about the weaknesses. Yeah, that's kind of how I would paraphrase part of what you're saying is that you know, every business has weaknesses and strengths. And uh a lot of times, particularly in founder-led companies, technical founders, they uh don't believe that they have uh very many weaknesses, or the weaknesses that they recognize they they diminish greatly. And realistically, buyers pass and they don't pass because of strengths, they pass because of weaknesses, and so it's very important that you just recognize those, embrace those. You're not selling based on weaknesses, you're selling based on strengths, and weaknesses are just part of everyday life.

SPEAKER_00 7:13

True. And they often either neglect or exaggerate the value of their own modes. Because strategic modes are critical for a company future and performance, and even I mean, in everyday reality, and not necessarily actually that they are truly engaged or analyzed when you moved into a data room or start actually, I mean, ranking your premises and assumptions for for the business case. And if you think about data room as a mirror of the organization, you have to really think that first of all, the a chaotic data room signals chaotic governance. It's almost synonymous. Missing contracts signal weak oversight, inconsistent financial definitions signal lose internal discipline. And those are, I mean, regrettably, uh, very bad indicators for anyone involved in the deal. Uh, buyers and firm management quality from the organizational quality. I mean, that's inevitable. Ineffective professionals understand that presentation is not cosmetic, it's informational by definition.

SPEAKER_01 8:32

I want to make sure we touch on the stakeholders in the preparation phase. So, in our six steps that we're going to review for the disciplined MA framework, we're going to talk about a lot of stakeholders, bankers, sellers, buyers, accountants, lawyers, escrow agents, tax advisors, wealth advisors, there's so many. The preparation phase is relatively limited to just the seller, assuming we're talking about a sell-side process, and if it's a buy-side-driven process, it's the buyer. How should a seller, a technical founder, think about what service providers to spend time with in the preparation phase, besides the investment banker, because they're sort of quarterbacking that. But should they engage with legal and wealth management and tax?

SPEAKER_00 9:18

I think it's critical for them to have a clear framework and a mapping of different stakeholders involved in a particular deal. Because at the end of the day, it is an exercise that promotes and requires alignment. If, for instance, the CEO wants liquidity, the CFO wants to wait, the board wants a higher multiple management, wants autonomy, and so on and so forth, then the preparation will become pretty much messy, if not incomplete. Therefore, an effective preparation includes hard internal conversations about valuation expectations, timeline realism, rule after closing, earnout tolerance, risk appetite. So all that actually is not just technical definitions. I mean, it's obvious, but there are people behind those different items, those different topics. And people have different expectations, and then align them is absolutely critical in order to move forward.

SPEAKER_01 10:23

Yeah. And an acceptance that just a lot will be unanswered, because you hit on a bunch of really key points around earnout tolerance and pay purchase price structure. And yeah, I mean, just to overanalyze all the different scenarios that could exist at the preparation phase or prior, uh I would describe as an improper use of time. The takeaways that we want our technical founders and audience to take from this preparation phase discussion. What are those those takeaways, Ricardo, from your perspective?

SPEAKER_00 10:57

From my perspective, three takeaways. Preparation is the first proof of seriousness because it separates ambition from readiness. Second, clarity protects valuation. The more coherent your narrative and numbers, the less discount bias would apply. Thirdly, being useful means anticipating friction before it appears. That's the discipline that defies effective professions at the end of the day. Because let's face it, and you know it very well, Joshua, preparation is not glamorous, but it's decisive.

SPEAKER_01 11:35

Yes.

SPEAKER_00 11:36

So what are your takeaways?

SPEAKER_01 11:40

I would challenge our audience or anyone in the preparation phase to think about the receiver of the information they are creating. CEOs, executives, owners, etc., excel and are phenomenal when it comes to talking to customers. They're the world's leading expert in their businesses' solutions and their customers' need. And they're just very articulate, very fluent. They're good at talking to employees, and they're also good at talking to shareholders or investors. Where they often fall short, or where definitely they are significantly weaker than the other categories, is speaking to the audience of the potential buyer. This is from the sell-side process. Buyers don't care about what customers care about in the same ways. And we often see sellers who are so well trained in the customer talk track that they completely lose the ability to have an alternative track. And I think that that's where the preparation stage can add the most future value to the MA process is thinking about okay, there's buyer X who's across the table. They're going to buy this company. Why? What do I need to tell them so that they understand the strengths of the business? And it's related to customer stuff, but it's not the same. And I think that, you know, time just spent cogitating on that can lead to great returns in the MA process. Absolutely agree. Thank you, everybody, for listening to episode two, our preparation, building the foundations for MA value. We will see you on our next episode where we talk about solicitation.