You've just been approached about serving on the Board of Directors of a pre- IPO start-up company. Is this a great opportunity or the Assignment From Hell?
Naturally, you will try to do your due diligence. The problem is that it is often difficult to find good information about private companies. One has to rely on such "soft" issues as "reputation." When "soft" information can make the difference between an a terrible decision and an outstanding decision, consider using the Scuttlebutt Technique.
"Networking" is a well-known technique for finding opportunities before they become generally known in the marketplace. Investment manager Philip A. Fisher has a technique he calls "Scuttlebutt." It is a combination of old fashioned networking and a social science technique called a Sociogram. Says Fisher:
"Most people love to talk about their competitors. Go to key managers in five different companies in an industry and ask each of them questions about the other four. You will emerge with a detailed and accurate picture of all five companies!"
Target company competitors are only one source of informed opinion. Other sources include vendors, customers, professors, trade association executives, former target company employees, etc.
Instead of asking respondents directly about your Target Company, you might say to respondents, "I think that I might consider some private investment in a company like Company A, Company B, Target Company, and Company C. I know you work for Company D, and I wanted to know if I could ask you some questions about these four organizations?
Asking direct questions about the Target Company might seem like the most direct approach to take. Keep in mind that such direct questions put respondents in the uncomfortable position of having to make absolute evaluations. Most of your contacts will be uncomfortable about this. There is the ethical issue that people don't like to make absolute evaluations about single companies they may not know very well. The result is that most respondents will retreat behind the bland statement of, "Target Company is a fine company." You may interpret that blandness as a ringing endorsement!
On the other hand, the technique we advocate asks respondents to make a relative evaluations of Target Company against its competitors. You may get more valid information using this approach.
Fisher used scuttlebutt as a method of making investment decisions. His approach is equally valid if you are contemplating a sweat equity investment. We have adapted questions from his classic investment guide, Common Stocks and Uncommon Profits (New York: Harper & brothers, 1958).
Do these companies have products with market potential to increase sales for at least several years? The purpose of this question is to identify companies who are harvesting profits currently but lack long term potential.
How effective is R&D in relation to its size? Looking at the financial ratio between total R&D expenditure and total sales is a crude way of thinking about R&D commitment. Such ratios can also be misleading. In some technology job shops, for example, what is called R&D may actually be costs associated with customer projects that were completed but not yet paid for.
In asking about a company's R&D efforts, market research is as valid as technology research. New England has its share of horror stories about management spending vast sums on R&D to perfect products for unprofitable markets. We cite Polaroid's Polarvision as only one example.
Describe the sales organization of these companies. In some professional service arenas, this question might read "Describe the client development capabilities of these firms." Few organizations have such a competitive edge that the world beats a path to its door without the intervention of an effective sales team.
Information about the sales operation is seldom discussed in financial reports of public companies. Fortunately, this information is easily obtained using "scuttlebutt" techniques. Of all phases of a company's activity, none is so well known to sources outside the company than its sales organization.
How would you compare these companies' profit margins? Sales are only of value when they lead to profits. You want to find out if the target company is doing to maintain or to improve profit margins for the future. Perhaps some "scuttlebutt" can give you a glimpse into future actions being planned by the company.
How would you describe the way these companies treat employees? Within an industry, it is generally known that there are "decent" companies. And it is generally known that there are companies who "burn up and discard" people. Senior management is often blind to its own reputation.
How would you compare depth of management? A small company can do extremely well under an able autocrat. What would happen if that key person was no longer available?
How would you compare the company's cost analysis and accounting controls? It is not difficult to churn out reams of information. The tough issue is how valid and useful is this information? How seriously does management act on the basis of information? The "scuttlebutt" method is helpful here in revealing significant problems that won't necessarily appear in the balance sheets.
How would you compare the integrity of management? Without breaking laws, there are ways in which senior managers can benefit themselves at the expense of customers, employees, and stockholders. Such people are generally known within their professional communities. The only real protection against being abused by such managers is to refuse to get involved with them.
Scuttlebutt requires that respondents trust you to keep their identities confidential. Confidentiality should go beyond promising not to name respondents. As a matter of business ethics, you should not reveal information if divulging that information might allow a listener to figure out the source.
Don't get alarmed or relieved on the basis of one individual feedback. If 60% of your sample of five talk about the same issue, you have discovered a piece of serious information that may be valid.
Serious information could be invalid information. The company may have already taken steps to correct the problem. In the marketplace, however, perception tends to have a reality of its own. Even a false perception can negatively impact the company's future.....and your own.
Laurence J. Stybel and Maryanne Peabody are co-founders of Board Options, Inc. of Boston, a corporate-sponsored, international consulting firm that focuses on career effectiveness of senior executives. There are twenty eight Lincolnshire International offices in three countries. Maryanne and Larry are members of the New England Chapter of The National Association of Corporate Directors and Larry serves on its Board of Directors. You can contact Maryanne or Larry at 781/736-0900.
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