Changing the focus: product to profitability; Companies doing an initial public offering need to...

While brilliant initial public offering (IPO) success stories such as those of Yahoo! and Amazon.com are widely known, the reality for many IPOs is quite different. Studies by Ernst & Young and data from Securities Data Corp. reveal a more realistic picture:

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* Most IPOs perform poorly in the first three years after going public--significantly underperforming the overall market in both operating and share price returns.

* Those that succeed view the IPO as a transformation process, while unsuccessful companies treat it as an event or short-term financial transaction.

* In retrospect, 62 percent of the executives in unsuccessful companies considered themselves ill-prepared for their IPO.

Why do so many IPOs wind up with these results? One reason is that companies going public through IPOs face two challenging and concurrent transformations. First, the business evolution required to add profitable growth, positive cash flow and shareholder value to their technology and product focus; and second, a cultural transformation from a private company or internal division of a large company to a stand-alone public company.

IPO executive teams face four critical challenges: 1) building and maintaining investor confidence to attract capital; 2) maintaining company value through the IPO process and beyond; 3) preparing the organization and employees to manage a public company that meets the profitable growth, return on investment and cash flow expectations of shareholders; and 4) executing the transition to a financially focused public company.

Building and Maintaining Investor Confidence

Attracting investment capital requires the new company's executives to demonstrate that they understand the investors' financial return and risk requirements, and are able to convince prospective investors that the new company will satisfy those requirements.

They must demonstrate how the new company will be competitive, profitable and generate shareholder value in the short- and long-term. In addition, quick and confident responses to questions or concerns raised by securities analysts, investors and lenders (in financial terms) must become second nature to them.

Realistic plans are required to manage the critical transformation from a parent corporate culture to an entrepreneurial culture. Executives need to prove that their business model, strategy and operating plans will provide outstanding customer value, sustainable competitive advantages in technology, products, innovation capability and a highly skilled and engaged workforce. Stringent regulatory requirements such as Sarbanes-Oxley must also be met.

At this juncture, the CFO plays a vital role as a presenter and supporter of other executive presentations, Q & A sessions with securities analysts, investors and lenders.

Maintaining Value During the IPO Process and Beyond

Extraordinary cooperation on multiple levels can make or break the transformation. Dealing effectively with transition requires all executives to demonstrate the leadership necessary to quickly design and implement critical change initiatives.

Paramount to the process is continuous communication with all stakeholder groups. Doing so assures that everyone's interests are carefully considered before and after the IPO and that commitments made are honored. This is achieved by company executives and operating managers meeting frequently with major customers, suppliers, investors and lenders.

Continuous, open and comprehensive communication with employees is also a vital part of maintaining business focus. This can be realized by frequent CEO, CFO and senior operating managers' updates for employees, along with personal visits to worksites and through the company newsletter.

Business unit finance managers can lead ongoing information sessions for employees, where the financial rationale and benefits of the required changes in operating strategies and organization are discussed.

Preparation for Management After the IPO

In cases of a spinoff from a larger company, management performance guidelines and rewards shift from those dictated by the parent to the new company's goals, strategies and business model. At this juncture, performance in many newly public companies changes; to a much larger degree, it's about being judged by profitable growth and cash generation. It's essential to implement performance measures that encourage managers to focus on financial results, along with technology and product results.

Without the parent company "bank" to fund investments, the new company must generate or raise its own capital, requiring a laser focus on cash flow. Quite simply, cash flow becomes a major factor in all investment decisions.

Once established, it is vital for new vision, values, mission and short- and long-term goals and strategies to be communicated in clear and unambiguous terms companywide. Aligning managers and employees with the new goals and strategies speeds the shift to a financially focused public company.

For businesses being spun off from large corporations, incumbent division managers are often appointed executives and senior managers of the newly formed pubic company. While they fully understand the products and technology of the business, they probably have little understanding of corporate finance, since corporate groups normally handle investor relations, financing and cash management.

Not only do they face a wide range of issues never dealt with before--stock exchange and government rules and regulations and oversight (previously the responsibility of the corporation)--but also they find that the "corporate bank" is no longer open. Managers who have not had return on investment and cash flow responsibility may be reluctant to take responsibility for financial performance if they are unclear about what their new roles entail.

Financial Management Development Strategy

There are four collective objectives that need to be satisfied during the IPO: building investor confidence; maintaining the value of the company during the IPO process; preparing the new company for speedy profitability to meet shareholder expectations; and successfully transitioning to a financially focused public company.

While senior management can elect to deal with each of the challenges individually, some companies take another approach. They start by providing executives and managers with the foundation upon which meeting all the objectives stand--strategic financial knowledge, information and tools. Their plans are based on bringing all executives and managers into customized management development workshops, starting immediately; followed by employee participation on a second tier.

Not only does this prepare the managers for the IPO and successful operation as a public company, but it also shows prospective investors that the company is serious about increasing managers' financial knowledge, skills and commitment to boosting financial results.

Strategic Financial Workshops

Before launching the workshop program, business unit executives and operating managers should be interviewed to determine their comprehension of the new company vision, values, mission, goals and strategies. Even at the executive level, there are often wide differences in knowledge and commitment.

The CFO of a newly public company said following such an exercise, "Our workshops provided practical examples and exercises that focused on identifying what factors determine shareholder value. It was critical that our management discover the significance of the shareholder value. They needed to learn the most beneficial approach to interact with investors, analysts and everyone involved."

Workshops in several companies studied focused on six key challenges that company executives and managers would face: 1) the business would receive more scrutiny from analysts, investors and lenders than it did as an operating division or private company; 2) changes would be required in strategies, organization and performance measures; 3) cash would become a significant factor in the company's success; 4) all managers would have two jobs--to build successful products and create shareholder value; 5) new ways to communicate the strategic and financial reasons for all changes to all employees would be vital; and 6) organizational transformation to an entrepreneurial culture would be imperative.

Executive workshops examine key factors that drive company valuation during the separation and beyond. Financial valuation models can be used to illustrate how changes in income and expense impact the valuation and share price. Senior managers must understand how their decisions directly affect shareholder value, and how to evaluate decisions about buying and selling businesses, long-term investments, financing, cash-flow planning, make vs. buy decisions, the effects of different strategies and performance improvement measures.

Specialists should be engaged to inform senior managers about areas requiring detailed understanding and analysis. These include government regulations, tax issues, currency issues, stock exchange rules and regulations and financing options and tradeoffs.

Operating management workshops provide managers with opportunities to discuss with other managers vital issues facing the business units, including:

* Definition of shareholder value, how it's created and how creating shareholder value provides value for customers, shareholders, suppliers, lenders and employees.

* The company's latest financial results and projected results, compared with those of competitors, to identify successes, shortcomings and needs for improvement.

* How the company vision, mission, goals and strategies are linked to revenue, profit, cash-flow goals and performance measures.

* Trends in internal operations' financial performance metrics as the basis for evaluating the operating effectiveness and efficiencies of the company and its competitors.

* Factors that drive revenue, costs, profit, assets and cash flow, and ways to maximize them.

* Actions that each manager can take to generate profitable growth and positive cash flow.

* The five crucial questions used to make business decisions.

* Approaches for working as business partners with finance in all phases of creating economic value.

Workshop participants' profit improvement recommendations can be collected in every workshop and given to management for evaluation, selection and funding. Results of chosen ideas can be added to individual and organization performance measures. Successful goal achievements should be publicly recognized and rewarded.

The most effective implementations often entail a top-down process, with the information cascading throughout the organization from the executive team, then filtering to middle management and to all employees.

Results of Financial Management Development Strategy

Companies that have employed the strategic financial management development strategy report results that include:

1) executives successfully responded to potential investors' and lenders' requirements, concerns and questions;

2) the two major transformations proceeded according to plan;

3) managers demonstrated substantial increases in financial knowledge;

4) executives and managers learned to speak the language of business finance within the company, and with investors, customers and suppliers; and

5) the new company's business vision, mission, goals and strategies, market challenges and opportunities, internal challenges and opportunities, financing needs and requirements for positive cash flow were documented and communicated to managers and employees throughout the company.

PENN POST is President of Post Associates (www.FinanceForManagers.com) in Newport Beach, Calif., and has been designing and conducting seminars promoting positive change within organizations for 25 years. A Certified Management Consultant, he is the author of Ten Ways to Improve Profitability. He can be reached at 949.706.0623.

RELATED ARTICLE: TAKEAWAYS

** Surveys show that most IPOs perform poorly in the market in their early years, and that executives at those suspect companies generally felt unprepared for going public.

** One way for companies to understand the dimensions of going public is to participate in strategic workshops that involve both managers and rank-and-file workers.

** In effective workshops, executives and managers learn to speak the language of business finance within the company, and with investors, customers and suppliers.

STRATEGIES TO INCREASE SHAREHOLDER VALUE

                                                   SHORT-TERM  LONG-TERM
STRATEGIES                   SALES  COSTS  ASSETS  CASH        CASH

Increase design wins in      P
  defined application areas
Focus engineering and        P
  marketing resources on
  key accounts
Exploit IP portfolio         P
Long-term strategic          P      S      P                   S
  partnerships to access
  leading-edge technology
Continuous investment in     P      S              S
  R & D
Cycle Time Reduction                P
Yield Improvements                  P
Aggressively reduce all             P
  costs
Minimize cash used in on-                          P           P
  going operations
Continuous investment in     P             P       S           S
  manufacturing
  capabilities

[c] Post Associates
4087 Rivoli * Newport Beach, CA 92660* (948) 706 0623
www.FinanceForManagers.com
A chart like this can be a good workshop exercise. Participants need to
work through the various strategies and determine whether they are
primary financial purposes (marked with a "p") or indirect effects of
the strategies (marked with an "s").