Guest Post by Dan Murphy
Common Pitfalls that Prevent Profitability in Direct Selling Start Ups

I would like to share a number of common pitfalls that prevent profitability in direct selling start ups. This comes from years of experience working with companies that have contacted me many times after making mistakes like these and then asking me to help them correct these issues.

Lack of Direct Selling Expertise

Many founders have started their ventures with only cursory experience in the industry. They have seen or heard of successes in this industry of companies started on a shoestring and quickly rising like a rocket with hundreds of millions in revenue. Although things like this have indeed happened, the much more common experience is modest success and many times failure.

Validate the Key Components of the Economic Model Before Launching

It’s obvious that one of the key components of any business is providing a product or serve that has a compelling selling proposition. This is a no-brainer, and yet this is where so many young direct selling companies stop. But you also must make sure that product or service can be sold with a times cost multiple that will support a competitive compensation plan while also contributing to the bottom line after commissions are paid. It’s seems very basic, and yet I’m always surprised how many companies launch with pricing models and compensation plans that don’t immediately or very quickly cover the projected overhead of the organization.

More than once I have met with executives who want to sell products that cost $10 and want to sell them for $40 MSRP, and then have a compensation plan that will pay out at close to 50%. The mathematics of this business case is a disaster.  A comfortable, hard good cost multiple is between 6 and 7. The compensation plan in this situation could support a 40% to 45% pay out.  Often in startup situations, since there are no sales, products are purchased at minimum order quantities, making the achievement of 6 to 7 times cost impossible. As the outset, it is critically important to create a plan which will quickly get to purchase quantities that support the needed margin. In the meantime, while the company is at this launch phase, it will burn cash.

Working Capital is Your Rocket Fuel

This brings me to my next point, which is the lack of working capital this has been a key factor in many companies I have seen fail. Working capital is like rocket fuel; without it getting off the ground is very difficult. In my practice, I have been contacted by several startups that have asked if I can assist them in a shoestring startup. I always say no.  It’s not that it can’t happen, that a shoestring start up can’t be successful. However, invariably it will take much longer than planned and be more painful.

Achieve Profitability in Every Area of Your Business

Within every direct selling business, there are actually several businesses; of course the most important is the commissioned sales. This is the primary focus of a direct sales business. The other businesses are the shipping and delivery of products, printed material as sales aids, new consultant starter kits, and incentives and events—all of these ancillary businesses must be profitable or there is simply a hole in the bottom of the bucket.

I will focus on just one of these areas for the purpose of this article as an illustration. The shipping and handling of products, is an area where many startups immediately adopt a mindset that it will be a cost center. After all, this is the era of Amazon Prime and customers have come to expect either free or very low-cost shipping.

It takes great discipline and ingenuity to not fall into this mindset; I have worked with a company facing this issue where their field sales force voiced their biggest issue as the cost of shipping. Management, working with the field leaders, lowered shipping expense to end consumers by 60% but at the same time increased the retail price of each item by $3.00. This increase was non-commissionable which the field was fine with. This change made with the agreement of field sales leadership made a significant change in the trajectory of sales at the Company. At the end of the day, the margin on shipping actually improved year over year.

In summary gather experienced management in the industry, make sure the core economics of your company will work in the direct selling model, working capital availability is critical, and achieve profitability in all areas of the Company.

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Guest Post by Dan Murphy
The Implications of a Trade War with China on the Direct Selling Industry

International trade is an important part of the world economy, especially between the United States and China. The US imports approximately $505 billion of products from China while the US exports approximately $135 billion of goods to China. We are all aware that the United States is taking steps to lower the imbalance of imports and exports, with a goal of protecting US markets from lower cost producing countries.

The Trump administration has to date imposed tariffs on approximately $36 billion with an additional $16 billion coming shortly for a total of $50 billion. These Chinese imports to the United States consist mostly industrial equipment. The Chinese have likewise imposed tariffs on a similar amount of US products, mainly agricultural products as well as steel and aluminum.

In an escalation of trade tensions, the US has threatened to expand tariffs on $200 billion of other imports. Reportedly, tariffs could begin at a 10% rate, and then escalate to 25% of the value of these imports. This new list of imports contain a number of products which US direct selling companies market to Americans. One example on the list is handbags. The timing of these additional tariffs being imposed would be before the end of this year.

A typical direct selling company in the US markets its products with between a 6 to 9 times cost multiple. This cost multiple can be explained in simple math that if a company purchases an item for $10 they charge the end consumer between $60 to $90 dollars for that item. This markup is necessary to support a lucrative compensation plan (usually paying between 40 to 50 percent of each sales dollar) to those that are selling the products, as well as the overhead to manage the business. A tariff of 25% would reduce the cost multiple from 6 to 9 down to 4.8 to 7.2. This would cause many sellers of hard goods to, of course, either become unprofitable or to raise prices to consumers by a like amount, effectively passing this bill on to customers. The impact of passing along a 25% price increase to consumers is difficult to gauge but I will take an educated guess that it will not be good.

As previously stated, the imbalance of trade between the US and China indicates that the US has far more goods that they can impose tariffs on than does China. However there are other tactics that they have at their disposal. China controls the value of its currency. From the period of 2000 to 2018, the value of the Chinese currency (RMB) has steadily fallen from 8.28 to the dollar to 6.49. This decrease in the value of the currency makes the purchase of Chinese products extremely attractive and has been blamed for the current trade imbalance.  In the near term, China has the ability to continue to lower the value of the RMB to offset the impact of the US tariffs, effectively negating the efforts of the US.

Another major impact on the direct selling industry is that 10 of the top 25 direct selling companies selling in China are based in the United States. You can probably surmise who they are. In 2017, China was the second largest direct selling market, and by the end of 2018 will certainly be the number one market in the world. With a decreasing value of the RMB, these US firms will see a negative impact when the Chinese currency is converted into US dollars for reporting purposes, creating a currency squeeze.

No matter how you look at it, these trade tensions are not good for the direct selling industry. The next round of tariffs will impact products sold to end consumers who will see higher prices due to what is, in effect, a tax on them.  Many of the largest companies in the industry will see declining profits, given that, in many cases, their fastest growing market is China. At the end of the day the best thing would be for negotiations to take place to provide certainty for business in general. However, at this time there are no negotiations taking place.

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Guest Post by Dan Murphy
The Right Way to Create a Sales Forecast in Direct Selling

Every year, usually after convention season is over and most direct selling companies kick into their high-selling season, another important task begins (or at least it should): the formulation of the sales forecast for the balance of the year, and the plan for the entire following year.

This is a good time to appraise how well your initiatives and tactics are working in the current year. Are we ahead or behind our plan? What worked and what didn’t work? Honest and clear answers to these questions will set the stage for the planning of the next year.

So many companies fall victim to repeating a different twist of the same ol’ plan year after year. This is not how a sales plan should be developed. Instead, a zero-based method should be applied with the key performance indicators driving the metrics that, at the end of the day, drive revenue. A zero-based approach means you start with nothing, and build your budget and plans from the ground up (rather than just take last year’s plan or budget and tweak it here and there).

A forecast and budget that is created without the overall strategic plan in mind is out of sync from the very beginning. What strategic initiatives will be important for the coming year? New products? New territories? New technology and social media initiatives?  Each of these has a definite cost that must generate a return on the investment.

At most companies I have worked with, the process for the development of the sales forecast is typically led by the finance department due to the nature of the exercise. However, if finance drives the process in a silo, the plan won’t be worth the paper it is printed on!

An effective sales and budgeting forecast must be a cross-functional exercise. The marketing department needs to put together an overall marketing plan that will govern the cadence for the coming year, usually driven by a travel incentive trip and a convention with specific monthly programs interlaced along with them. Importantly, the percentage of revenue spent on a convention and travel incentive trip should be no more than 4%, and I like it even more at 3%. Monthly programs which typically include discounting of product or some reward should be no more than 25% of the mix of sales with the balance sold at full price. These programs should be designed to not only sell product but increase activity and sponsoring.

Once senior management agrees with the strategies, initiatives, programs and the necessary investment and resources to make this happen, the plan must then be turned over to the sales department. It is critical that they understand and embrace the plan. Too many times I’ve seen a good plan fall flat on its face because it just gets thrown over to the sales team, with the expectation to “just go promote it.” Your sales team must be part of the decision-making process, and then they must also have the opportunity to fully process the plan with the various paradigms they represent in the field.

Any good plan includes specific KPIs. The most common for direct selling, regardless of the specific initiative, typically include sponsoring rate, the attrition rate, average order size, activity rate and the orders per active consultant. Retention is also a key driver we so often overlook. There will also be certain KPIs that are specific to an individual tactic. Be sure to account for these, too, so you can judge the effectiveness not only of the plan holistically, but also the individual efforts. This information will prove to be very beneficial for future plans.

It is up to the sales team to commit to the sponsoring numbers, the activity numbers, and the sales order numbers.  The plan must be broken into regions if that is how the company is organized so that each particular individual is fully accountable for their actions and outcomes. Incentives for the sales team should be structured around the achievement of these goals. I’m always so baffled at how common it is for a direct selling company to create an incentive criterion that doesn’t directly impact the company’s sales goals. Don’t let that happen at your company!

Of course, direct selling is a volatile business: as soon as a new year begins, a process for reporting and performance analysis must begin. In my experience, this is best accomplished by a post-period de-brief, consisting of a cross functional group from sales, marketing, finance and operations. The group collectively reviews the actuals versus forecast, and discuss what went well and what the challenges surfaced. This is the venue to brainstorm any mid-course corrections, and where the forecast becomes a living, breathing tool.

Once the sales plan has been finalized, then the calculation for inventory management needs to be aligned so that over-stocks or back orders are avoided. This supply chain process deserves an entire article all to itself, so I won’t cover those details in this article. I will say that your supply chain and logistics team will appreciate nothing more than an accurate sales forecast, so take it very seriously.

The biggest mistake I have seen in regard to sales forecasting is that the ownership of the plan belongs to finance or senior management alone and not with the entire organization. I believe the real ownership belongs with the sales team. Without this critical step of creating ownership within the sales team, the plan remains the responsibility of management and others, and sales will simply do the best they can to be of support. Sales as a supporting role never works; they need to make the plan come alive and make the necessary mid-course corrections needed to make the plan a reality.

With the combined efforts of the entire organization led by sales, there is a solid road map based on specific activity that will make a sales plan a reality.

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Guest Post by Dan Murphy
Striking the Proper Promotional Balance: How Much Discounting Is Too Much?

As we enter a new year, I thought it wise to discuss a key driver of performance in any direct selling business: The mix of promotional offers. As executives and stakeholders in the industry, we know that what moves our business is excitement and enthusiasm.

This energy can come in many different forms: New products, a national convention, a travel incentive trip and most recently, via social media and public relations. I am reminded of a time in the history of one business I was running that it came from the arrest of a consultant for indecency – a charge which was later dropped. The surprisingly positive outcome came thanks to the national public attention and led to the largest increase in sponsoring in the history of the Company! It’s the best example of the adage “There is no such thing as bad press” I’ve ever personally experienced.

One area of great caution when it comes to generating excitement in a direct selling business is the implementation of promotions. Promotions, of course, have an important place in our tool kit of options to generate excitement and enthusiasm. The proper mix of promotions designed to motivate leadership development, sponsoring and sales to either customers or hostesses are crucial to success.

But if this tool is overused, there is the risk of building a reputation as a High/Low seller with customers and consultants waiting for the next big sale to make purchases, creating successive cycles of “boom” followed by “splat.”

A Formula for Proper Discounting

A good rule of thumb when finding your promotional balance is to start with the blended times cost multiple for the business (meaning the relationship between the retail price of the products and their fully loaded landed costs). For example, if the times cost multiple is 7x (meaning I buy an item for a cost of $10.00 and sell it at full price at $70.00), then I can afford to have between 25% to 30% of the business in a period be sold at a discount of between 10% to 30% off.

However, if my times cost multiple is only 5x or 6x, then I must only have 15% to 20% of my total revenue be sold at a discount of 10% to 20% off.

Generally, if your compensation plan pays in the range of 40% to 45%, a mix of 25% of the revenue being sold at a discount of, say, 25% off will yield an after-commission margin of 40% assuming a 7 times cost multiple, which is adequate to cover the overhead and produce a solid profit in most businesses.

Here’s how that works:

• Full Retail $70
• Total Units Sold 20
• Units sold at a discount = 25%, or 5 at $52.50
• Discount offered = 25%, so the discount is $17.50 x %, or 87.50
• Total revenue from this item is 15 x $70, or $1,050 (from full retail price), plus 5 x $52.50, or $262.50, so Total Revenue is $1,050 + $262.50,  or $1,312.50
• Total Cost of goods sold at $10 per unit is $200
• Total Commissions and Over-rides (assuming a 45% plan payout) is $1,312.50 x 45% = $590
• Margin after commission and Cost of Goods is $1,312.50 (Total Revenue) – $200 (Total COGS) -$590 (Commissions) = $522.50
• Margin Rate equals $522.50/ $1312.50, or 39.8%

 
Don’t Forget About the Impact Discounts Have on the Field

Whenever you are making a decision to offer discounts off of normal pricing as a means to generate excitement and revenue, keep in mind that you are also essentially asking your field sales force to CO-OP the price discount with you.  This is a fact that is often overlooked.

Here’s an example of what I mean: An item that would normally sell for $70 full price would generate commissions and overrides of $31.50 assuming a 45% total payout.  That same item sold at a 25% discount would generate commissions and over-rides of only $23.63, a decrease of 27% in total payout.  The Company, on the other hand, gets to discount a product by 25% or in this example $17.50 but the true cost is only $8.77 as the other half is offset by lower commission payout, making the effective cost to the company of 16.7%.

Here’s what it looks like when you work through the assumptions above:

• Full Retail $70
• Discount Retail $52.50
• Commission paid on full retail $70 x 45% = $31.5
• Commission paid on discounted products $52.5 x 45% = $23.63
• Commission if 20 sold at full price = $630
• Commission paid if 15 sold at full price and 5 sold at a discount = $590.50
• Savings in commissions to the company due to discount is $630-$590.50 = $39.50
• Total price off to the Company of offering 5 at a discount is $17.50 x 5= 87.50
• Total price off after accounting for reduced commission $87.50 – $39.50 = $48

 
This may sound confusing, but these details are what your internal team (especially those in marketing and finance) should be reviewing on an ongoing basis. Usually this occurs on the front-end in a period promotion planning session and on the back end by a post-period debrief.

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Guest Post by Dan Murphy
How Direct Selling Companies Can Conduct a Straightforward Financial Tune-up

Anyone who is a veteran of the direct selling industry generally loves the industry. This is one of the few business models where you can do good while you do well. Executives have the honor of offering an opportunity that has the potential to change people’s lives for the better. It is also a responsibility to make sure that the opportunity remains viable over a very long period of time.

For this reason, I find it necessary to conduct periodic financial reviews for direct selling corporations, to safeguard a company’s position and to ensure its long-term success and viability. I’ve conducted dozens of these reviews over the years, and I’ve never once had a review not results in a significant positive results to the bottom line.

I’m also always surprised at how many direct selling companies do NOT go through this exercise of what I call a financial tune up. So that’s why I want to introduce the concept to you in this article.

So what is a financial tune up? It is a detailed review of the Key Performance Indicators (KPIs) of a company, as well as a review of the various financial cycles. KPIs include the metrics that result in revenue and growth within a direct sales company. Financial cycles include Revenue, Inventory, Margin, Freight and Distribution, Information Technology and General Overhead.

A complete review requires a session of key stakeholders with the organization over a period of typically about two days, provided the proper historical and current data has been assembled in advance. The goal is to examine KPIs and each cycle to determine if industry standard benchmarks are being achieved or exceeded, where there is a gap, and determine steps to achieve or exceed industry benchmarks.

This is a very disciplined approach, but it pays off in the end. You’ll find that over time certain assumptions have been made which are actually excuses for suboptimal performance. Some of these assumptions could be:

• Our customers will simply not pay freight rates equal to our costs so we subsidize lower freight rates in order to grow the business.
• Once we achieve scale we will be able to purchase products at lower costs allowing us to achieve profitability. Until then, we will lose money.
• The current overhead is a long-term investment that will help us grow rapidly once we hit break even.
• The KPIs will improve if we could only find a good field development leader to run our sales efforts.
• Yes ,we have a competitive compensation plan which we copied from (insert current rising star company here), but the margin in our products less the payout of the plan doesn’t produce adequate dollars to support even minimal overhead. How does Company X do it and we can’t?
• You don’t understand, we are not like any other direct selling company. We are unique and the industry standards just don’t fit us.

 
These are simply a handful of the statements over the years that I have heard executives make in support of the current status quo. If you believe and hold tightly to any of the above statements, as well as any other number of excuses, performing a financial tune-up will be a waste of time. If you are ready to examine honestly every component of your business that you will find great benefit in going through this type of exercise.

So let’s get started: Step one is the review of all KPIs. First, do you have KPIs? Many companies I work with know what KPIs are, but they don’t actually have them in place and track as a way to manage their business. Examples of KPIs include the sponsoring rate, the retention rate, activity rate, orders per active, average order size, paid as leadership statistics, reorder rate, auto-ship average life, fast start achievement rate, performance of each months new consultant class, event attendance, % of attendees that actually order. If you don’t have KPIs, the first step in a financial tune-up is to agree what KPIs are important for your business and a commitment to start tracking them.

Once you have your KPIs identified, track how have they been trending over time and what are the root cause of changes, whether positively or negatively. Set concrete goals that are tied to actual financial outcomes. Determine what the life time value of a new consultant joining your business is. This will drive decisions regarding support for sponsoring initiatives, as just one example.

The revenue cycle review should include a line review. A line review looks at each and every product in an objective manner, which calls for a judgement as to what it’s reason for being is. In order to conduct a proper line review, SKU and style history is needed. In most company’s 20 to 30% of the merchandise drives 70 to 80% of the revenue. What is often discovered is that the product line is bloated, and poor performing items remain in the line due to high inventory levels, or because it is a top leader’s favorite product.

Poor performing items need to be identified, and a specific plan put in place to eliminate the items over time. This is a tough process, but you must challenge yourself to establish concrete measures for success. In addition, new items or planned new items should be reviewed to determine if the margin in the items meets the overall objective. Lastly, a pricing review should be conducted again with margin objectives in mind. The outcome of this review should be implemented at the earliest possible opportunity, usually at the start of a new season.

Inventory control and management are crucial elements for success and should also be reviewed, generally this review coincides with the revenue review. For this section, an inventory aging report should be prepared.  Old and discontinued inventory does not appreciate with age. Tying up capital in bad inventory can be a serious drag on a company’ success. This cash is better to be freed up to invest in other parts of the business—everything from technology to human capital.

One of the most critical and common issues I see at both small and established companies is what I call “betting on the future”. Entrepreneurs start their business but quickly learn that the key to a successful business is to have an adequate “X cost multiple”. In a typical successful business, this multiple is anywhere from 6 to 10 times the cost of the products. Let me repeat: That’s 6 to 10 times the cost of the products! This level of margin is necessary to fund a competitive compensation plan.

If the compensation plan doesn’t provide adequate rewards, it will prove impossible to attract and retain a sales force. The error that I mentioned previously is that a start up often doesn’t have the purchasing power with its suppliers to get the cost required to power the model. Many founders make the decision to start with a cost multiple of 4 or 5 with the idea that as they get to scale they will be able to get better pricing from vendors. This is a fine concept, but then the initial losses from operation will need to be funded from seed capital. Any company that is following this philosophy while at the same time boot strapping their launch will inevitably fail.

We now come to the cost side of the equation: I refer to any direct selling company actually operating multiple profit and loss centers. What I mean by this is obviously there is a P&L for the sales of actual products to end consumers. In support of that, there are other profit loss areas: Freight charges and cost of delivery is a separate business that needs to stand on its own; printed matter sold to consultants and the cost to produce that printed matter; fees charged for information technology and the cost to deliver that technology. In the case of a party plan company, there is the hostess program which includes all the benefits provided to someone acting as a host or hostess. All of the items that I just previously mentioned have to run at a profit. It is the responsibility of management to measure and take action to bring each of these areas into a profit position.

I am going to go deep on one of these areas mentioned above: Charges for freight. This is often a sore subject—we all here about e-commerce companies that offer free freight. A successful direct selling company will charge enough to cover their actual cost of freight as well variable warehousing and the direct cost to process an order. Management needs to know their costs as well as their package profile. One way to ensure that you are getting a good deal from your carriers is to work with a respected auditing and negotiating partner as a third party (let me know if you would like recommendations). I have seen in case after case where, at no cost to the Company, this third-party expert finds opportunities in freight costs. I personally know of one company which has saved over one million dollars over the last four years in lower freight cost directly due to negotiations that were quarterbacked by one of these companies.

There are a number of ways to make adjustments to this cost structure without causing a revolt from your field leaders. In one case, I worked with a company that shipped very heavy products. As a result, the freight charged to the end consumer was significant because they made sure that they more than covered their costs. However, the “freight issues” were a concern for the field. After careful review and consultation with leaders, they came upon a unique solution. They brought down and simplified freight charges while at the same time boosted morale and increased the rate of sales by a factor of 40%. They added two dollars to the price of each item, which was non-commissionable. The commissions to the field remained exactly the same as they were prior to the change, but the cost of freight to the end consumer was reduced by as much as 67%. The field was over the moon excited with the change, and sales went from plus 10% to plus 16% immediately following the implementation of the change.

Once again, the same posture as presented in terms of freight cost and charges needs to be established with printed matter, information technology and the hostess program in the case of a party plan company.

Finally, let’s talk about general overhead, or SG&A. These are all the other costs that have not been previously covered. Typically the largest element in this category is people to man a home office and executives to run the company. There are, of course, secondary buckets of cost such as credit card discounts in order to have a merchant account, printing costs, fixed warehousing costs, all utilities including telephone, heat, light, internet connectivity, etc. This is an area that needs to be watched carefully and managed skillfully. My advice is to run as lean as humanely possible at all times. I am not suggesting to be penny wise but pound foolish. But I’ve seen too many companies increase their costs too quickly, only have to make drastic cuts later when it could have been avoided.

In summary, there is a tried and true model to success in this industry:

• Set and manage to KPI objectives.
• Sell products that are 6 to 10 times their cost.
• Offer a lucrative compensation plan that supports sponsoring.
• To the extent possible, keep your costs variable by using outsourced resources.
• Tightly manage the overhead.

 
The outcome will be a profitable company from the outset. I am a firm believer that a direct sales company can be profitable at almost any level of sales if you’re diligent in managing your finances.

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Guest Post by Dan Murphy
The 5 Steps a Venture Capitalist Takes to Value Your Business

In the world of direct selling, one of the most difficult issues includes capital formation and how to make your particular company attractive to a venture capitalist in order to raise the necessary capital to take your company to the next level of growth. In this article, we’ll discuss how VCs (Venture Capitalists) think about valuing business, and how you should think about it as you prepare.

Everyone thinks venture valuations are black magic and arbitrary. But there’s actually some science behind it. The methodology below is a grounded way that VCs arrive at valuations.

Venture Capitalist Principals for Direct Selling Valuations

The process a VC takes to produce a term sheet valuation is quite simple:

1. Estimate exit valuation range. Venture money always wants a way out. This is an important consideration to ensure that in your business you understand that this is the end objective of venture money. Don’t start down this road if you want to build and own your business over the very long term.

2. Build target ROI with safety margin. The Return on Investment (ROI) needs to be grounded in key performance indicators for your business: sponsoring, retention, activity, average order size and leadership development.

3. Divide exit valuation by ROI to get current acceptable valuation.

4. Sense-check (strongly) against the rule of thumb values.

5. Check if this is too much/too little money for the business plan.

Let’s dig into the details of each of these principles.

1. Estimate exit valuation range.

VCs start with the end in mind. They’ll triangulate your business model, your addressable market, and your buyer universe to identify a range of likely exit values for your business.

Note that likely is the key word here – VCs know that the typical exit is in the low $100s of millions so it takes a pretty strong case to convince them a unicorn valuation is in the exit range.

2. Build target ROI with safety margin

VCs work backward by an expected ROI. The average multiple for a “home run” VC exit (which drives a portfolio) is 16x. This is driven by the Pareto principle in venture investing – because of the high failure rate of startups, the successes need to be home runs to drive portfolio returns.

But of course, VCs will actually need more than the 16x at the outset. This is for two reasons:

* First, the math here doesn’t account for dilution from future rounds. So earlier investors will demand a higher “expected ROI” than growth stage investors – probably at least double the ROI.

* Second, VCs are wrong often and they know it, so they’ll build in a safety margin into their ROI to compensate for mistakes. They don’t know how many of their portfolio companies will be home runs, so they’ll actually shoot for a little higher than 16x to compensate for this.

So the big question is what ROI do VCs look for? There’s a lot of chest-thumping around “we need 100x!” but we feel it’s not actually that high. We think a good estimate is anywhere from 20x-40x (that’s exit cash divided by invested cash). This is actually a great question to talk about with your VCs, so you can tune this even more specifically with each potential investor. Some VCs might consider this controversial, but if you can’t have this discussion openly, you probably don’t want them as your investors.

3. Divide Exit Valuation by target ROI

If we take our exit ranges of $100M or more, and divide by target ROIs of 20-40x, we end up with a rough startup valuation range of $2.5M to $50M.

That’s a pretty common range of valuations you see for venture stage startups. The range feels large, but bear in mind this is for startups from Seed to Series B. For brevity, we won’t do the math for each individual series here, but the calculations for Seed, Series A, etc., individually all fall within their more specific ranges.

4. Sense-check strongly against rule-of-thumb values

After all of this precise, results-driven math, the dirty secret of venture capital is that everyone still triangulates against market values.

The good news is those ranges are wide – ballpark US direct selling businesses at $2-6M for Seed, $10-40M for Series A, and $30-$200M for Series B in 2017. So all of the work we’ve done so far isn’t a write-off, but the market will definitely encourage a VC to nudge the valuation in either direction.  One example to determine that nudge is revenues – a Seed/A/B startup should be in the $500K/$2M/$10M revenue range, respectively. And if you fall above/below that for your stage, expect to be on the high/low side of your above range, respectively.

5. Check if this is too much/too little money for the business plan

VCs generally look for about 20% per round, so divide your valuation by four to figure out how much is the ticket size (glossary: ticket size = how much their investment amount is).

This again gets a nudge and is a big driver of what pushes valuations around within their market ranges. The key here is that (honestly, for reasons unknown) the 20% is fairly constant. So if there’s a strong case for you to raise a larger round, then you’ll get both more cash AND a high valuation. Great!

For example: if you’re a Series A company, the valuation ranges start to widen – from $10-$40M. What’s the difference between $10M and $40M valuation? The $40M business here would have strong proof that they’re ready to productively scale up their sales force. This will drive a larger ticket size (roughly $10M). So they would ideally show that they can invest $10M in scaling the business NOW and achieve solid ROI.

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Guest Post by Daniel Murphy
Time for a Compliance Check Up?

Over the course of the last twelve months I have been asked to act as an expert witness on four separate occasions. An expert witness is someone who has either the experience or the credentials to opine on a particular subject area and whose opinion is accepted by both parties in a legal matter.

For direct selling companies, these actions typically involve a distributor who is suing their Company either in court or in front of an arbitrator. The scenarios have involved a claim of wrongful termination due to a Company terminating a distributor for pursuing another opportunity then proselytizing back to their original Company’s sales field. The claimant typically sights that they were within their rights as an independent contractor to pursue another opportunity and requests damages for lost income.

This is generally where it gets interesting. Counsel for the distributor will typically, as part of their discovery, ask for copies of the distributor contract, the compensation plan and the Company’s policies and procedures. This is where issues typically arise.

Many startups that have become significant in size may have copied their contract from another company, as well as their policies and procedures, and simply given a rewrite to make them fit the terminology of their Company. This is not a good thing to do. It is crucially important that all of these documents are drafted by a skilled attorney with thorough knowledge of Independent contractor law and that the contract works in concert with the policies and procedures and the compensation plan.

Even if all of these documents were prepared by experts over time, changes are made most typically to the policies and procedures or the compensation plan that cause a disconnect between the three pieces that then open a Company up to questions regarding the meaning or intent of their legal relationship with their distributors.

In direct selling, Spring is often a great time of year. The launch of new products for the year may be behind you, and the craziness of convention is still a ways off. I would urge every Company to take the advantage of this time and bring the appropriate resources together to review these documents with the assistance of a legal advisor with experience in this field.

Once you have a well-working set of documents, the most important step is now for the Company to absolutely and without exceptions follow their own polices and contract. I know this sounds pretty elementary, but you will be surprised how often a company runs afoul of making an exception for someone due to special circumstances which violates their own policies. This inevitably opens them to a charge that the policies and contract are selectively enforced. It is important to have a chief compliance officer who must be involved in all such questions who is not a member of your sales or marketing teams. They must ensure equal treatment for all and ensure that the application of policies is fair and impartial.

This is an industry of entrepreneurs who pride themselves on quick action and fair play. The suggestion of a compliance check may seem like overkill and unneeded. However, once suit has been filed, even if it is a frivolous action for millions of dollars and the Company is forced to dedicate significant resources and funds for a defense, doing this sort of review will be time well spent.








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