* RECORD, Volume 30, No. 3 Annual Meeting and Exhibit New York, NY October 24–27, 2004 Session 28PD The Actuary as Entrepreneur—Growing the Small Actuarial Firm Track: Smaller Consulting Firm Moderator: IAN G. DUNCAN Panelists: DANIEL T. COX DAVID C. FLORIAN MICHAEL S. MIELE Summary: Actuaries are not generally thought of as entrepreneurial. Many actuaries have established and operate small businesses, and a few have grown start-ups into large corporations. How did they do it? This session features some successful actuarial entrepreneurs. MR. IAN G. DUNCAN: I'm a consulting actuary in New York. I am this year's chairperson of the Smaller Consulting Firm Section, which is sponsoring this session. Last year when we sponsored a session on marketing and developing the smaller consulting firm in Orlando, Fla., I took a show of hands from the audience and asked how many of those in the audience were smaller consultants or sole practitioners. I was surprised that only about half the audience was in that position, but it turned out the other half comprised insurance company people who were thinking about their next career. I'm interested in a show of hands from you. How many of you are, as of today, smaller consultants or independent consultants? I'd say that's about two-thirds of the audience. The rest of you are concerned that maybe this is something that you might want to do in the future. _________________________________ *Copyright © 2004 Society of Actuaries Note: All handout materials are available through the link on the table of contents. The Actuary as Entrepreneur—Growing the Small Actuarial Firm 2 I have a second question for you. How many of you belong to the Smaller Consulting Firm Section? How many of you have never heard of the Smaller Consulting Firm Section? There's one honest person. We are a section that is devoted to the advancement of individual consultants and smaller consulting firms, and not only the technical needs of our members, but also the business needs: how to be a better businessperson and how to develop or grow your own firm. That's what today's session is all about. We have with us three actuaries, all of whom have built, developed, sold or grown successful firms of one kind or another. They're from diverse backgrounds. I'll let them introduce themselves as they speak, tell you their stories and tell you what made them successful. We'll learn how they became entrepreneurs and how they got to the point of developing and selling successful businesses. Our first speaker is Dan Cox from Chicago Consulting Actuaries (CCA). He's going to talk a little bit about some of the financial aspects of raising capital to develop your firm. MR. DANIEL T. COX: Ian asked me to talk a bit about capital-raising, and I've tried to give a fairly complete outline. I'm probably not going to be able to get to it in the detail I would like because there are certain points I want to dwell on, but I thought you'd like to have a checklist if you ever need to go back to the slides. First I'll give you some perspective of where I'm coming from, and Ian asked me to cover my biography. I'll talk about what sets entrepreneurs apart, look at what investors seek, go over capital-raising checklists, discuss the business plan a bit, discuss sources of capital a bit and then talk about the capital-raising process itself. A brief reminder, which I think will be a good segue into the other session, is that while you're doing all this, you need to keep your mind focused on building the business. First of all, I should say I'm not a venture capitalist. I started as a consultant and, as Ian said, did get the actuarial credentials more as a union card, but I started as a pension consultant for a small actuarial consulting firm in Nashville. It was the first firm that Mercer acquired after becoming Mercer, and we were doing all its pension calculations. I soon found myself running Mercer's Nashville office. Mercer then moved me to Atlanta, and I ran the Atlanta office in the southeast area, and eventually I found my way in Chicago, managing the Chicago office of Mercer and also the Chicago-Milwaukee area. I was with Mercer for about 12 years, and I left in 1986. I then moved over to Aon Corporation and began to move into the entrepreneurial phase. I joined Aon in 1986 to help it get into the consulting business. I actually built and ran Aon Consulting Worldwide for 14 years, until April of 2000. During that time, I was doing some consulting but mostly was involved in looking at actuarial consulting firms, making acquisitions and trying to pull together what became a diverse organization. I think when I left there was about $750 million in revenue. Today it's in excess of $1 billion. The Actuary as Entrepreneur—Growing the Small Actuarial Firm 3 I also, while at Aon, ran a number of the life insurance companies but was the point person when we sold Life of Virginia and Union Fidelity Life Insurance Company to G.E. Capital back in 1996. I have also participated in life management and in life transactions on the sell side. As far as being an entrepreneur, I've had brief skirmishes with entrepreneurship. My first organization was a bootstrap organization in 1980. The most recent organization that I've managed and run was a start-up organization in 2002, which was funded by a strategic investor. Since retiring from Aon in 2000, I've been primarily working as a venture catalyst, which is a term of art for people who don't invest a lot of money but can help in starting a business, and I'm currently working with a couple of start-ups and am invested in another one. I'm also working with CCA to help it build its health and welfare practice. What sets entrepreneurs apart? If you're looking to become an entrepreneur, this is something you need to bear in mind. The first thing is placing your own capital at risk. Another is that you need customers to survive, and I think these are two big items that are different from working in a large corporation. You no longer are drawing the paycheck anymore, and you have your own skin in the game. Your rewards are also heavily dependent. If you produce something, you can get a big payoff, but the bonus is more than 30 percent to 40 percent of pay. It can mean whether or not your family eats for a year or two years. Another thing that sets an entrepreneur apart in general is the need to wear many hats. You no longer worry about whether or not something is your job or whether or not you have the expertise, but particularly early in the game, there's a need to do whatever is necessary to survive. What about actuarial entrepreneurs or actuaries as entrepreneurs? What are the special distinguishing attributes? One is the ability to step outside the comfort zone. A lot of people view this profession as one where people like to stay inside a comfort zone and not move out and begin to stretch themselves. If you're thinking about striking out in the business by yourself or moving your business to a higher level, you need to rethink that. You need to decide whether or not you are able to step outside your comfort zone and do some of the things that maybe you don't think you're good at. Because you need customers to survive, you have to learn to be a marketer. You're going to have to learn to sell your product and yourself. That involves certain skills, sales skills, which actuaries do not have a large reputation of possessing. You also may need to take a broader view of your professional role. How many of you knew Jim Anderson or who he was? I had the pleasure to know Jim. He ran Tillinghast for years and also is credited with inventing universal life. One of his favorite subjects over cocktails was the fact that this profession is selling itself too narrowly. Actuaries tend to think of themselves too narrowly. One example he would always give his actuaries is: Who is better prepared to value companies? It's The Actuary as Entrepreneur—Growing the Small Actuarial Firm 4 interesting that actuaries today are beginning to get involved in the valuation of stock options, which I think may be one step in that direction, but you have to take a broader look at what you can do. Maybe one of the best examples of this is a fellow by the name of John Dewan. Have you ever heard that name? John was with a company that Aon bought. I never had the pleasure of knowing him, but he started a company called Stats Inc., which provided baseball statistics. He sold it for about $45 million, and this was a hobby that he had, an avocation that he had, but he was good at it because of his actuarial profession and his actuarial skills. You also need to have networking skills not only to enable you to raise money, but also to help grow the company. The final thing is a high risk threshold. A lot of us actuaries spend our lives learning how to do better jobs of evaluating risk. We're perhaps the experts at it of all the different professions. If you look over the careers of some of the best and most successful entrepreneurs, possibly their strongest attribute was that they were too ignorant to know what risks they were facing, or they probably wouldn't have done some of these things in the first place. Assuming that you're through the checklist, and you're still an entrepreneur and ready to move forward, as you're building your business or starting your business and are thinking about raising capital, you need to think about what it is that investors are looking for. The first thing they're looking for as you go to ask for money, and it doesn't matter what level you're asking for money, is an executable business plan. What does this mean? Basically, it means a business plan that is realistic and can likely be accomplished within the confines of the funds that you're saying are required to do that. It's something that's doable. It's not pie in the sky. It's not a vision. It's not a hunch. It's something that is doable. It's been well thought through and is realistic. We'll talk about the business plan more in a moment. The next thing that they're looking for is a strong management team. For you young people, that's often a disadvantage because what they're looking for is a track record. They're looking for a bit of gray hair and somebody who's shown the ability to do this before. That's the reason younger people often team up with some people who have been in the industry longer, in some fashion: to establish that credibility and give them the credibility to move forward. Investors are looking for investment returns commensurate with some of the other goals that they're seeking. If they're pure investors, venture capitalists, they're usually looking for much higher returns, for example, than strategic investors, who might be looking for other things. They might be looking to build a platform. They might be looking for you to build a platform that can be brought into the business or possibly for you to build a business that will be complementary to the ones that they already own or are expecting to acquire. The Actuary as Entrepreneur—Growing the Small Actuarial Firm 5 This can be an advantage for you, by the way, as you're building the business, as far as strategic investors are concerned. If you're building a business that's complementary to one that they have, they might have some businesses that can become good strategic partners for you as you build your own. If they are angel investors, they may be looking to play a mentorship role and want to spend some time sharing their experiences as to where they're putting the money. You have to evaluate what the goals are of the investors that you're approaching, and to some extent, that would dictate the requirement for the investment returns. Regarding the exit buyout strategy, if they're venture capitalists, they're often looking to see if you thought through your exit strategy because they're wanting to know when they'll get their return. But if they're strategic investors, perhaps they're looking for an option to buy the business some day when it becomes of a size that they think they can take in-house. All of them are looking for management at risk. They want your skin in the game as the management and want to know that you're fully invested in the business. Let's look at the capital-raising checklist. These are my four S's of capital-raising. You need a compelling story—that's going to be primarily your business plan. You need a business structure in place. You need supporting evidence. You also need to think through what your staffing is going to be. That's going to be primarily your key employees and your upper-level staff at the outset. Let's talk about each of these in turn. In terms of your story, we're going to talk about the business plan a bit more. I have a fairly lengthy checklist as to what that might look like. There's also the investor presentation. A lot of people don't think about that as they're developing their plan, but you are going to need to do one, and that's more than a PowerPoint slide show. When you're preparing an investor presentation, and you have an investor that's interested in talking to you, you need to learn as much as you can about that investor and what it's looking for. Think through in advance how that fits with your goals and the company that you're building. You also need to think thoroughly through the questions that might be asked. There's a tendency to try to think through how you can fake answers to those questions and how you can smoke these people. If these people have a lot of money to invest, they've had a lot of these presentations before. The thing you need to think about doing is being honest and giving full and complete answers to those questions. If the answer is you don't know, say you don't know because at least they know that you're leveling with them, and that's where any of us likes to put our money. You need to think through what the structure of the business is going to look like, and that means what corporate documents you're going to need and shape, what The Actuary as Entrepreneur—Growing the Small Actuarial Firm 6 type of corporation you're going to be, what the shareholder agreement is going to look like and what regulatory filings you need. You need to be aware of these things, but these don't necessarily need to be nailed down when you begin to talk to strategic investors because one thing that is sure to change is the shareholder agreement. That's going to change probably every time you bring in significant money. Another thing that is likely to change is the capital structure of the fund as you begin to develop various types of debt and equity to be able to accommodate however it is the investors tells you they'd like to invest their money. What kind of supporting evidence do you need? You're going to need financial statements. If it's already a business, you're going to need fairly detailed operating statements, income statements and cash-flow analyses. If you're a relatively small business, you're going to want to have available a fair amount of personal financial information because again what the investors are looking for is what resources you have and what resources you've invested in the business, and they want to see that you're invested in the business. Most of them would prefer you not be overextended because they don't want to become a black hole that you're going to just to keep the business surviving from day to day. You also need a working plan or a case study. You need a working beta site, or something of that sort, hopefully with testimonials. This greatly improves your opportunities of getting investors involved, particularly as you're beginning to talk about significant money. More and more people are getting involved in developing software plays, and it's difficult to sell vaporware. You need to have some type of working model, and hopefully you have this in place somewhere. If you can bootstrap the operation long enough to get it to that level, you're in a much better position when it comes time to talk about valuation. If you can get letters of recommendation from people who have done business with you, that also is a strong case to take to the investors. I've talked about the management team a bit. What about the board and the advisory board? The board and the advisory board are almost as critical as the management team because these are the people who are going to give you the credibility. They're going to help extend your network and provide a lot of the networking that you can't do, particularly if you're fairly early in the game. They may be knowledgeable in helping you build the business in terms of obtaining new clients and may be on the boards of clients that you want to approach. They may also be able to provide some money themselves, particularly if they tend to be angel-type investors who at that point in their lives are in a position to put up some money. The Actuary as Entrepreneur—Growing the Small Actuarial Firm 7 You also need to think about whether or not to have an advisory board in addition to your board. There are a number of people who like to help start-ups but because of some of the liabilities involved with being a board member or being an executive officer would just as soon forego that and take a lower-profile position in the company. That's often a reason in and of itself to create an advisory board. This is going to be critical for you as you move forward. You need to think through it carefully, and you need not to jump too quickly just because someone seems to have a lot of knowledge. There are a lot of people now who have taken retirement packages from large corporations and have led fairly narrow lives, frankly, and they tend to think that they're ready to do something new and want to do something new, but a lot of them have never built a business or have never been involved in building a business. You need to think through that as you're selecting your board and also your advisory board. What about the business plan? I don't think you can spend too much time on your business plan, and even if you're not ready to raise money, even if you're going to bootstrap for a while, it's important to begin to frame this plan because it reminds you what it is you're trying to do, why you're trying to do it and how you want to go about it. There needs to be an executive summary. This needs to be clear and concise, preferably, and needs to be written in a way that hooks someone after a couple or three sentences. It does need to be a summary. I've seen executive summaries that are 30 and 40 pages long. That ceases to be an executive summary. You want something that is a quick read, and you need to recognize as you're drafting this that this is something that may get distributed by itself a number of times because at some point you're going to get into this phase of do we or don't we get a confidentiality letter. When you're making a preliminary inquiry about money, you typically don't send out confidentiality letters because nothing comes back. You might have the executive summary so that you can share it with people, and if you have trade secrets, keep those in the business plan because that may put you in a better position to do that to get it later, but it also should develop interest so that someone wants to read your business plan. The first step I would suggest is to define the opportunity and the problem as you begin to develop the body of the plan. What is the opportunity that you're approaching or the problem that you're trying to solve? State how you plan to solve the problem. What's your unique solution for this particular problem or your unique way of taking advantage of this opportunity? Out of this often emerges a mission statement for the company. Next, you want to provide a good company overview. Where is the company today? If you have one part-time employee, and it's your wife or your husband, say so. Don't try to hide where the company is today. Complete disclosure is what I always advise. The Actuary as Entrepreneur—Growing the Small Actuarial Firm 8 What do you plan to do? What's your business model? In other words, what's the basic business that's going to come, and how does it operate? How will it make money? Finally, what's your execution strategy? How do you plan to bring this all off? If you've done a good job of selecting your management team, you want to spend some time talking about your management team and laying out the members' credentials so that you establish the credibility fairly early on in the process. The same goes for the board and advisors. If you have clients, it's a good idea to talk about them because again this gives you a working model of people who will say that you're doing a good job and also helps establish your credibility. Regarding strategic alliances, you need to be able to talk about those if you've developed any. You need a good discussion of the market. How big is the market? What is your target market? How do you plan to approach this market? There are lots of times people think the business plan is to say, "This market is $1 billion, and if I can get 1 percent of it, that makes my company worth X." You have to do a more thoughtful job of that, of talking about the market and what your niche is in that market. Talk about the competition and show your knowledge of the competition. One of the most commonly found statements in business plans about competition is, "We don't have any. We're unique and have no competition." All businesses have competition if they're doing something. If not, if they have a good idea, they're going to have competition soon. When you say you don't have competition, you think that makes you look strong, but it makes you look naïve because you need to show you've thought through these things, know what you're facing and know what's going to keep you out in front, if, in fact, you're going to be in front. Let's discuss a financial plan. You need to present at least a five-year plan of what you think the business can realistically achieve over a five-year period and what your uses of the cash are going to be. It's also a good idea to put a projected balance sheet in there, maybe one year out, three years out and five years out. If fairly detailed inputs are going into the plan, I always like to put it in an Excel spreadsheet because it's not at all unusual for people who are thinking about investing wanting you to send them the spreadsheet so that they can put in their own assumptions and maybe stress test your business plan. It should be backed up with an Excel spreadsheet that you're in a position to share so it's well-labeled and documented. The financial plan also relates well to the capital requirements. Many times you see a business plan where there's a financial plan that looks like it's been thought through okay, and then the capital requirements aren't in sync with the plan at all. How much money are you going to need, and when you are you going to need it? Try to phase the capital requirements as much as you can. A lot of people going The Actuary as Entrepreneur—Growing the Small Actuarial Firm 9 into this say, "My mission is to raise as much money as I can." The more money that you raise when your business is in the infancy stages means that you're giving up more equity. You want to stage and think about how much capital you need and when you're going to need it, and be frugal. Be realistic but be frugal, and if you can have staged capital requirements, that means you're more likely to hold on to more equity in the end, which is what you want to do if you're building a successful business. Talk through the risks and the opportunities. Show that you're knowledgeable about the risk and what you expect to do about those. Let's talk about capital sources a bit. First of all, I've mentioned entrepreneur or intrapreneur. That's probably the easiest way to be an entrepreneur and not have to take a lot of risk, and that's if you can get your company to let you put more at risk or some company for building a business for it. Look at your own resources, and you have a lot more than you think you do sometimes. These are some areas that you might want to look at. Look at clients. I'm not advocating taking advantage of noncompete agreements or ignoring noncompete agreements, but most of the actuarial consulting firms that have been built have been built with existing clients. That's a fact. They're often a good source of capital if they're willing to give you a longer-term agreement. You can hang paper on that. The Small Business Association (SBA) is also a good source, and I should mention the SBA has a Web page that you can go to that posts your business for possible angel investors. This is a laundry list. I'm not going to spend a lot of time on it because I want to be attentive to my colleagues, but this takes you through the other stages that you might look at in terms of looking for capital. Hopefully you know what these terms mean, but in terms of angel investors, they're typically individuals. It's often a good way to go if you're just getting started, and again they may want to play a role in growing the business. Select carefully because lots of times these individuals have a high expectation of their own abilities and may have unrealistic expectations for what kind of money they want to get back out of this. Incubators are a good place to go. There's the National Business Incubator Association (NBIA), an incubator association. It has a Web page, and there are more and more incubators growing up. This is a good place to go if you need some infrastructure and possibly also capital sources. Venture capitalists are typically looking for companies of over $50 million of value or that will soon get to that level and then enter a high-growth mode. I'll tell you a couple of places I've heard are good sources for looking for venture capitalists. Pratt Scott is the guide that I think lists about 1,200. There is another organization that you can find if you type in "venture capitalists" that will send you a subscription with about 15,000 names on it. Public offering is probably the last step in the process. That's where a lot of people The Actuary as Entrepreneur—Growing the Small Actuarial Firm 10 want to go. The threshold is rising all the time because of all the regulation involved, and you're probably now looking at something north of $100 million of revenue to begin to realistically talk about going public. Maybe that number is $200 million. This is a good segue into some of the remarks of my colleagues because it's here to remind you that as you're worrying about where you going to get the money to survive, the main step in the process is to continue building the business. It's the No. 1 priority, and cash is king. Always be looking for ways to conserve cash and build cash. Marketing and networking are important ways of doing that, and also I recommend staying lean during the process. Once you get your first fund raise, there's a tendency to splurge a bit. I don't care what size organization you're running; you always have MR. DUNCAN: Thank you, Dan. That's helpful in setting the framework. Our next speaker is Mike Miele. I worked for Mike for two years in a start-up, and he's going to tell you all about being lean and mean. MR. MICHAEL S. MIELE: I have a few more questions to ask the audience. How many of you have been in your own business for less than five years? How many for more than five years? How many of you who are in business for yourselves have fewer than five employees? How many have more than five employees? It's a good mix. I am going to talk about building the business, but I was hoping Ian would tell you my story because he would tell it better than I would. The first thing is, we did start a business in my basement and sold it in 2000. We managed to do it without doing a single thing on Dan's list, but I wish I had known about that stuff when I started the company because we probably wouldn't have had to sell it to keep from killing each other. I was a consultant at Price- Waterhouse, and in 1995, I left to start what wound up being a software company. The reason I started it was I was working seven days a week. I was never working in New Jersey, where I'm from. I was constantly on planes going somewhere. I said, "There's got to be a better way to do consulting. Maybe I'll do it a couple of days a week." Some of my customers were willing to hire me as an independent consultant, so what started as a way to improve my quality of life quickly became a business that was growing fast. For those of you who are thinking about starting your own business, let me warn you about a few things. First of all, your quality of life will not improve if you start your own business. You'll have more freedom to do things that you want to do, but at the same time you have a tremendous responsibility to your partners, to your employees and to your family that goes way beyond working for a corporation. I would encourage you to try it, though. I remember standing on the edge: Should I do it? Should I not do it? I'm afraid. I can't do it. My wife said to me, "What, are