(Originally published in ClickZ, June 2001) by Eric Picard
As you might have heard, AdForce closed its doors last week. CMGI shut it down after failing to find a buyer. What a strange world we’re living in. It makes you wonder whose balloon is going to pop next, doesn’t it? It wasn’t so long ago that these companies were awe inspiring to many of us in the industry. How quickly things change.
So what is an agency or advertiser to do? If you make decisions about or manage the relationships with your technology partners, maybe we can come up with some guidelines for you on how to judge a company’s stability. The world is a dangerous place right now, and getting caught unprepared if your ad-serving infrastructure suddenly goes up in smoke could really hurt.
Let’s start by looking at the public companies. Once, you could assume that if a company was public, it would most likely be around in a few months. Not any more. Being public actually works against most companies in our space these days.
A very well-known industry analyst once told me that any company with a stock price of under five dollars is focused only on appeasing the investors, not on doing business, and certainly not on innovating. At the time, he said he didn’t even pay attention to those companies. I have to wonder if he still operates on that principle. Today, companies in our space with stock near or above five dollars are like superheroes.
I just looked at the list of 43 stocks I’ve been tracking for the past three years. It’s made up of companies either active in online advertising or peripheral to it. I noticed that 34 are trading under five dollars or are no longer trading at all. Of those 34, 12 are trading under one dollar, and 17 of them are no longer actively trading. Some have stopped trading because of merger or acquisition, but most are just out of business.
So how do you make sure you’re safe?
- Look at the makeup of your technology partner’s customers. And I don’t mean its “portfolio” — since this often contains customers no longer working with the company. I mean active customers.
- Ask your contacts for active customer references. This might be a tough play, but at least you’ll be able to judge the stability of the company. If a company doesn’t have one customer willing to say something good about it, you might want to reconsider.
- Find out how much operating capital the company has. DoubleClick is an example of a public company in our space with lots of operating capital. 24/7 Media is an example of one without any operating capital.
- Make use of the fact that the company is public. Look closely at its public disclosures. Read quarterly reports. Read analyst reports. Judging which companies are in trouble is mostly a clear and commonsensical act.
- Check if the company traded as an over-the-counter or bulletin board (OTC:BB) stock. If so, you should be especially wary, because the regulations about reporting here are much less clear. Since there is less regulation, companies trading as OTC:BB are often seen as stock scams at worst and as a little shady at best.
The main change these days is that since many companies have been de-listed from the Nasdaq, as victims of the times, they have ended up on the OTC:BB. If the company is a real business, you should be able to tell pretty easily. One quick test is to verify that its “gallery” or case studies are real, not mocked up. Be direct and ask — even ask for real customers you can talk to if you feel uneasy.
One of the first questions I ask a company is if it is public or private. If it’s a small company and it’s public, I immediately ask if it’s an OTC:BB.
Now that we’ve looked at public companies, we should review how to judge the stability of a private company. It’s not so different, but some of the information isn’t available publicly.
First, make sure that the general items are covered from above — and especially focus on customers. Since public companies are accountable for things that they say in public, they usually are relatively credible (minus the marketing spin). Private companies are not so tightly regulated, so make sure to do your due diligence.
Usually, private companies’ financial health is the hardest point to establish. And today, this is the most critical factor to review. There are, usually, some indicators:
- Private companies generally start up through bootstrapping or venture financing. If it’s the latter, you’re in luck. It’s a huge win to get investment from a venture capital (VC) firm, and the general response is to issue a press release.
- Review the company’s press releases, and try to figure out how much money it’s raised.
- If it has been growing and hasn’t raised any money in the past six to eight months, your warning bells should go off. The only situation in which that shouldn’t worry you is if the company is bringing in lots of revenue. This is tough, given the market right now.
- Next, you should figure out how much time it has to get profitable. Once you do (explained below), feel free to ask the company directly how it plans to achieve profitability. Again, you may not get an answer, but it doesn’t hurt to ask.
- Get a general idea of the company’s burn rate by using the following guidelines:
- How many employees does it have? Usually, the company will tell you.
- Where does the company have offices, and how many people are in each?
- What kind of capital expenditures might it have? If it’s an ad-serving company, how much is it spending on server farms?
- This is closely held competitive data, so a company is unlikely to just hand it over, but you can make some educated guesses about these things:
- Figure that a company with 30 employees is burning $150,000 a month for salaries (if it’s aggressive).
- If the company is in New York, figure that it’s paying big-time rent (even with some of the new deals opening up). An office for 30 people will run roughly $35,000-45,000 a month, depending on location and other costs beyond rent.
- That gives us close to $200,000 monthly without even getting to hardware or server infrastructure.
- When you look at (a minimal) server infrastructure and costs for setting up and maintaining the business, we’re talking about $250,000 monthly, or about $3 million a year.
- That gives a company of 30 about two years of life if it’s raised $6 million. You can work out the various scenarios for different sizes and funding.
- I’m being quite conservative here, and this is based on a whole lot of assumptions. For instance, if the company happens to have offices in New York and San Francisco, you can imagine that the costs are a lot higher.
- If the company is too large for the amount of funding it has, it will burn out fast. If it’s too small for the amount of business it has, you’re going to get horrible service.
So now you’re an expert in evaluating those companies you’re working with. Go out and look at them. There’s no time like the present.