Several years ago, a venture-stage company that we’ll call ACME Metals built a commercial-scale manufacturing plant to produce a substance used by high-end computers and cell phones, using an innovative production process ACME had previously developed.
When it engaged Fairlead, ACME was already successfully producing several grades of its product, attracting customer interest and competitors’ attention. However, due to underinvestment in its financial staff and systems, ACME couldn’t show whether its process was profitable. What they knew was that they were burning cash and had less than a year before it would exhaust the funding allocated to ACME by its private equity investor.
The raw materials used in the production process were expensive and had to be procured six months in advance, forcing ACME to invest heavily in inventory. This investment helped explain its negative cash flow. But without a functioning accounting system, it didn’t know if operating income was counteracting or exacerbating the drain on cash flow.
The financial statements were incomprehensible, and Fairlead subsequently uncovered significant errors in the accounting that forced us to recreate three years of financial statements.
Fairlead’s mandate was to help ACME prepare and arrange for additional financing or a company sale before the company ran out of money in about twelve months. We knew we had to prepare credible financial statements as part of the fundraising process, but demonstrating that ACME’s plant was more efficient than its competitors was of existential importance. ACME had to prove to skeptical industry engineers that it could deliver high-volume, medium-grade products more efficiently than its competitors and profitably produce low-volume, high-grade products that its competitors couldn’t.
Thus began our race against the clock. With less than a year before the money ran out, implementing a manufacturing-focused ERP to measure plant efficiency was out of the question. So while our accounting team worked to restate historical financial statements, our analysis team worked with the VP of Operations, to replicate the production process in Excel.
Each product batch required a month before it was ready for final testing and shipment, with several batches at various stages of production at any given moment. The processing model improved with each new production run. First, we calculated a baseline efficiency calculation that validated the founder’s original thesis. Next, the VP of Operations studied the data he now had at his fingertips, made adjustments, and improved plant efficiency during the fundraising process.
With proof of the plant’s performance, ACME garnered significant customer and competitor interest. After a competitive auction, ACME’s largest customer bought the company at a premium to its invested capital three weeks before running out of money.
(ACME also delivered three years of audited financials at close so the buyer could check a box on its due diligence list).
The hero of this story is ACME’s founder, who had the vision and ability to develop and build a better production process. But, while his accomplishment was necessary, it was insufficient. ACME had to demonstrate its breakthrough to skeptical industry insiders and engineers with limited capital and time. Young companies always need more time and money to do everything right, so they prioritize and sometimes make mistakes. These mistakes create challenges when they need more capital that can be overcome by focusing on what’s essential to prove the value of the company.