CHAPTER 15
Financial Governance: Always Necessary

Table represents the seven sub-playbooks.

The second component of the governance playbook is financial governance, which is always necessary.

This is another relatively short chapter with exactly the opposite message of the last chapter. Where your regulatory governance needs merely to secure your license to play, deploy a zero-tolerance approach to financial governance. Require complete integrity and compliance.

Every one of you knows a story of some executive that used their best judgment in recognizing some revenue in some period that others might not have recognized to deliver on their commitments. Every one of you knows a story of how that executive ended up causing severe reputational damage to themselves and their company when they did it again and again and again until they got caught.

Don't do it. Don't let anyone else do it. Own the miss. Take the short-term hit. Fix the problem. Recover. Move on.

Financial

Keep a close watch on all the financial items you looked at during due diligence:

  • Financials: Income statements, cash flow statements, balance sheets, general ledger, accounts payable and receivable
  • Off balance sheet liabilities
  • Credit report
  • Tax returns—federal, state, foreign
  • General accounting policies including revenue recognition
  • Risks attendant to foreign operations (e.g., exchange rate fluctuation, government instability)
  • Debts, their terms, and any contingent liabilities
  • Gross profit margins
  • Fixed and variable expenses
  • Gross profits and rate of return by each product
  • Inventory of all products, equipment, and real estate, including total value
  • Financial projections
  • Industry and company pricing policies
  • Economic assumptions underlying projections (different scenarios based on price and market fluctuations)
  • Capital expenditures, depreciation, and working capital arrangements
  • External financing arrangements

Business Structure and Operations

Look at the business structure and operations from the perspective of regulators.

  • Company's articles of incorporation and amendments
  • Company's bylaws and amendments
  • Investors and shareholders—shares outstanding, owners, options, warrants, rights, notes, any other potentially dilutive securities with exercise prices, and vesting provisions
  • Company names and trademark brand names
  • Products and services, including production cost and margins—follow the product through the key steps to understand strengths and gaps:
    • Design and innovation—especially if the company is design led. Look how they acquire ideas from others if they do that.
    • Production—looking at the whole supply chain from sourcing materials to handling materials to physically producing and managing inventory
    • Delivery and distribution—looking at the whole ecosystem of partners, allies, and contractors to understand how products and services move through the system
    • Service—looking at the guided accountability of the front-line service providers
  • Supplier database, purchases by supplier
    • Share of their business
  • Purchasing agreements
  • Consents
    • Ensure you have consents for all key contracts
    • Customer
    • Vendor

Material Contracts

Look at contracts from the perspective of regulators.

  • Nondisclosure or noncompete agreements, any guarantees
  • Company purchase orders, quotes, invoices, or warranties
  • Security agreements, mortgages, collateral pledges
  • Letters of intent, contracts, closing transcripts from mergers or acquisitions
  • Distribution agreements, sales agreements, subscription agreements
  • Loan agreements, material leases, lines of credit, or promissory notes
  • Contracts between officers, directors, or principals of the company
  • Stock purchase agreements or other options

Product and Intellectual Property

Look at products and intellectual property from the perspective of regulators.

  • Services and products: customers and application
  • Company's patents, trademarks, and copyrights
  • Product inventions, formulas, recipes, or technical know-how
  • Rights owned data and digital information
  • Work-for-hire or consulting agreements
  • Who owns or controls the rights to the intellectual property?
  • Has the IP been patented?

Customer Information

Look at customer information from the perspective of regulators.

  • Customer databases, subscriber lists and sales records, revenue by customer
  • Purchase agreements
  • Customer communication
  • Refund policies
  • Rebates
  • Contingent liabilities
  • Guarantees
  • Status and trends of main relationships
  • Description of the competitive landscape within each market segment
  • Litigation or threats of litigation
  • Standard communications and correspondence
  • Pending litigation or threats of litigation
  • Unsatisfied judgments
  • Insurance coverage and policies
  • Professional licenses and permits

Employee Information

Look at employee information from the perspective of regulators.

  • Employee contracts and independent contractor agreements—including noncompete, nondisclosure, severance agreements, and outsourced work to freelancers, consultants, and so forth
  • Workers' compensation
  • Payroll information and employee tax forms. Look for:
    • owner's either not paying themselves a fair salary or over-paying themselves to increase or decrease profits
    • leaders and managers' compensation as a data point on the strength and expected retention of leaders and managers
  • Human resources policies and procedures
  • Employee benefits, retirement plan, and insurance

Infrastructure, Physical Assets, and Real Estate

Look at infrastructure, physical assets, and real estate from the perspective of regulators.

  • Real estate, including office locations, warehouses, current leases, and titles
  • Fixed assets, including product inventory, furniture, fixtures, and equipment
  • Information technology infrastructure: data centers
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