Simplicity

The best ideas in business and life are most often the simplest ones.  I believe it is the job of the finance professional to take very complex data and analysis and communicate its essence in a way that non technical / non financial people can understand easily.  The highest form of art in business is taking complex ideas, functions, and needs and addressing them in the most basic and intuitive way.

Here is a great example of how two large and successful companies approach products and consumers very differently. 

THE BUDGET and the MULTI-YEAR PLAN: Business Tactics

The budget. Not much more needs to be said. For most people there is no glamour in budgeting or financial planning. There are no warmly lit dinners with interesting clients that just got back from Safaris in Kenya. No box seats behind third base with the Founder musing about his days playing college ball. No company sponsored weekend of skiing at Bachelor’s Gulch with interesting gifts greeting you on your return to the hotel room.

While never does the CFO get presented fancy hardware for building the financial plan that maps how the company will meet its goals, the budget and its sibling – the multi-year plan, when built correctly are key tools in a company achieving greatness.

Greatness does not just mean reaching sales or profit goals, or getting the best valuation based upon impressive financial forecasts. It also means providing the entire management team with specific goals around which to rally. These plans are the roadmap of how to get from where you are now to where you want to be. They lay the framework of weekly meetings for the staff to measure progress, they create interim opportunities to “ring the success bell”, and they help build a winning corporate culture - one where all members of the team buy-in to the corporate goal and understand how their performance contributes to everyone’s success. That is the difference between a financial plan for bankers (revenue and profit) and a financial plan that you use to run a business (driving a team to a common goal).

I am not going to get into the raw detail of building a budget, because the formal process – while similar for all companies, can vary based upon the business, its sector, its customers, the accounting systems, etc. That said every budget has some basic requirements in common. Forecast revenues, expense, headcount, capital investments, how long it will take your customers to pay you and how long you have to pay your vendors, etc. Some of the work is done in excel, much of it in the financial accounting systems – customer by customer, cost center by cost center, line item by line item.

The most effective budgeting though isn’t just done by having each business unit leader fill in next year’s Jan-Dec revenue and expense estimates alongside the actual Jan-Dec of the prior year and then having Finance come back with “cut 15%”. It should be part of a strategic review of the company’s industry, customers, product set, peer group, and staff. Where is the industry going? Which sectors, customers, products, and geographies have experienced the greatest growth and have the greatest growth potential? Which sectors, customers, products, and geographies are the most profitable and why? What parts of the company are the most productive – not just in terms of sales or profit, but in terms of just getting things done? Realistically what can the company do this year and how does that set it up for bigger success in the years to come?

This strategic view outlines the long term plan and addresses long term opportunities and challenges for the business. That “big goal” should then be translated into a multi-year plan which sets forth the major achievements necessary to hit that goal. The budget then is not an isolated annual project – it is the detailed roadmap for the next 12 months as part of the longer 5+ yr journey toward a company’s long term strategic goal and vision.

With that in mind, here is a suggestion for the optimal financial planning hierarchy:

A) Set the strategic vision for the company: Where are we going? What is our vision? What are the core products and services we provide and why are we better than the rest? Where is our industry going and why is it a great place to be? Why would high energy people want to be part of this industry and company?....

B) Build a multi-year business and financial plan that supports that strategic vision: In order for us to achieve our vision, what is the year by year plan that we must meet to achieve our goal? What customers should we strive for and how do we meet their needs? How should our products evolve? What are the resources we need and when must we have them? What should we build and what should we buy? What are our year by year revenue goals and what financial and staff resources are required each year to hit those goals? What capital will be required?.... This is the multi-year roadmap.

C) The budget then becomes the 12 month tactical plan: With the multi-year plan as the long term roadmap, what are the specific goals we need to meet every month and quarter this year? What customer accounts must we close? What product investments must we make? What partnerships / acquisitions must we enter into? What staff changes must we put into effect? How should we compensate our employees to hit this year’s goal? Do we have sufficient capital to meet this year’s goals? How will we track our performance on a weekly, monthly, quarterly basis?....

Most effective companies understand these, with particular attention to A (vision) and do C (budget) on an annual basis with varying levels of success and effort. B (multi-year planning) tends only to get attention in the formation stages of the company and when necessary for financing or other corporate change events (M&A, major industry or customer changes). I contend that B is a critical component that should be more of a “living” plan rather than something that gets completed on a periodic basis when an investment banker needs a multi-year forecast. It is unrealistic for most companies to maintain a fully detailed multi-year plan that is updated every month, etc. (I have done that and it is a ton of work.) That said, if a company builds and maintains a 6 quarter rolling forecast (by effectively extending its current 4 quarter budget 2 quarters and updating the forecast quarterly), it is not terribly difficult to maintain a high level multi-year forecast with some basic assumptions.

So what are the take-aways?

• Make sure you have a clear strategic vision for the company relative to the “end game” and the markets and customers you want to serve. Communicate that vision with abandon.
• Layout a multi-year plan (even if it is high level) that breaks the company’s big goal into the key milestones you believe you need to hit to achieve that goal.
• Be specific in that multi-year plan and build it from the ground up as much as possible – “These are markets we need to activate each year”, “These are the products we will need”, “These are the key customers we need to land”, “This is what the organization needs to look like”, etc.
• Be flexible - while the strategic vision for the company will likely not change, the specific path the company takes rarely follows the path originally laid out.
• Build a current year budget that details the things that need to happen on a month by month basis by business unit as part of the multi-year plan.
• The month by month plan needs to be detailed such that the reports and dashboards that each business unit use to measure performance on a daily / weekly basis track the performance implied in the budget.
• Make sure each business unit is having weekly meetings to track progress and allocate resources to critical projects.
• Extend the 4 quarter budget an additional 2 months and build a regular quarterly forecasting process such that the company always has a living rolling 6 quarter forecast.
• Tie that 6 quarter forecast into the multi-year plan creating a direct link from the monthly performance to the company’s 5+ year plan.
• Build individual compensation plans and performance review processes such that each person understands how they get paid to meet the monthly, quarterly, yearly goals.
• Make people accountable for their performance – even top management - and create many opportunities to ring the success bell.

Budgeting and building financial plans, when part of mapping the journey toward an ultimate goal, should energize the troops rather than put them to sleep. Any goal oriented employee wants to know how they can make a difference and strongly desires specific targets to meet and exceed. If communicated effectively, the strategic vision, the multi-year plan, and the budget will provide those targets and motivate the team to climb the mountain. Without that roadmap and those goals, the team may work hard for a while, but a high performance goal oriented team which craves direction and records to break, will soon look elsewhere to stretch their talents. 

-Bob

GOAL SETTING & ACHIEVEMENT - Business Tactics

Situation: It is early December and the Board of Directors has approved the final 2011 budget that took 3 months for the senior team to pull together. As the new CFO, while you are anxious that “the number” for 2011 is aggressive compared to what the company did in 2010, you feel pretty good that the team was highly engaged in building the plan and laying out the major milestones required. The senior team knows what it has to do and feels sufficiently uncomfortable, but is not screaming in pain with what will be required.

One day, while you are refining the management reports and tracking tools that the team will use to measure performance and forecast resource investment, you decide to walk into the CEO’s office to discuss what changes the company should make in its employee goal setting and evaluation process to accommodate the 2011 company goals. Jim the CEO, while a big fan of company events and building employee morale, has never been an advocate of investing in formal individual employee goal setting, evaluation and feedback processes. “It is our job to communicate the revenue and expense goals to the employees and tell them what they have to do. If they do it, they get rewarded, if they don’t they should be worried about their jobs. Big formal employee quarterly or annual evaluation processes just add administrative burden and take up time better spent out with customers closing deals. Remember we are not IBM, we are a $50mm company.” You respond “Jim, you are right that it takes time for each employee and his / her manager to sit down and talk about individual goals, how they are linked to company goals, and then follow-up with written reports on performance. If we don’t do that though, how will Jenny the new hire in marketing understand how what she does every day contributes to the bigger goal of growing revenue 100% for the year? It also makes it clear to her what she has to do to shine, get promoted and make more money.”

How strongly should you push?

Setting and achieving big goals requires detailed planning, team buy-in, broad communication and clear connection of individual performance to the goal.

All of us have goals and dreams, small and large. Except for a gifted few that are born with IQs of 180, have music flowing out of their fingers at age 4, or are lucky enough to have unlimited access to resources, most of us are forced to set and achieve little goals on the path to reaching our dreams.

For an organization, the effectiveness of that goal setting, the planning involved, and the techniques used to direct and motivate a workforce will determine whether a company will achieve great things and have ecstatic stakeholders or be mired in mediocrity or worse – out of business. Will it climb the mountain or stand in the meadow wondering what it is like to hang on the side of El Capitan.

Goal setting is a basic function of a successful organization. Set a long term vision / plan, detail the milestones necessary to meet that vision / plan, then drive the team to hit the milestones. Pretty simple, pretty basic. Planning and tracking progress whether it is long term forecasting, yearly budgeting, monthly goals, or weekly staff meetings is an essential part of the DNA of an organization and the only way to get a group of people working together toward a mutual goal.

The senior management team and the Board understand clearly how setting business and financial goals, planning, reporting / tracking, accountability, etc. directly relate to creating value (financial and otherwise) for the business and themselves personally. The challenge for senior management and the Board is institutionalizing “buy-in” of those goals throughout the organization.

While employees get satisfaction when an organization is successful and achieves great things, I believe most people look at goal achievement in generally three ways:

(1) the financial and other personal benefits of achieving their near term individual targets (hitting sales goals, new client / product goals, cost reduction goals, closing that deal, etc.);

(2) the feeling of pride and accomplishment of being a part of a winning team / an industry success story / being a game changer; and

(3) a general knowledge that if the company does well and they have a stake in the success - at some point in the future when the company goes public, is sold, or gives capital back to the shareholders, they will get something.

In order to align personal success with organizational success, the company must create “buy-in” throughout the organization and directly connect individual employee goals with corporate goals and the long term vision. How do you do that?

• At the top of the organization set a long term vision for the company and communicate that vision often – “This is our long term goal”.

• Set reasonable intermediate and annual stretch goals with the Board and investors that layout the path to reach that long term goal.

• Get input and buy-in from the team on the intermediate and annual goals, adjust as necessary and layout the major milestones to hit those goals.

• Drive the company to build team and individual action plans that set forth what has to happen on a day-to-day, month-to-month basis to hit those goals.

• Build individual and team incentive plans that reward goal achievement and over reward over achievement.

• Institute individual and team employee performance evaluation systems and tools to measure performance against those goals.

• CREATE MANY OPPORTUNITIES TO “RING THE BELL”. Success breeds success, strong and excited employees attract more strong and excited employees, achieving small goals will lead to achieving big ones and result in many reasons to celebrate individual and group performance. This last point is the critical connection point between the corporate goal and the employee. If done properly, it lays the foundation for a great corporate culture.

Organizational success is directly tied to goal setting and achievement. If you set a long term goal people believe in, reasonable short and medium term goals that create many opportunities to “Ring the Success Bell” and reward performance then you will be building a “winning” corporate culture that will attract the best and the brightest and maximize the chance for success. If you set unrealistic goals that lack buy-in and rarely allow you to celebrate “wins”, then corporate culture will suffer, people will become unmotivated, the best will leave, and achieving the organization’s long term goals will become very difficult. In business, as in climbing El Capitan, the cost of failure of setting unrealistic goals can be devastating.

-Bob

For those of you interested in knowing what it is like to hang on the side of El Capitan in Yosemite Valley, this clip will show you what it is like. 

Youtube Video - El Capitan Climb

BUSINESS INTELLIGENCE vs. FINANCIAL REPORTING – Business Tactics

Situation (continued from prior post): Ok, you finally closed that institutional round of funding, have begun the process of productizing the core functionality that will become the new software business, you have a strong Board of Directors in place, and you are building out the development, sales and marketing teams. One of the first big hires you make is Jim West, a top software sales guy who got tired of the selling large ERP systems and wanted get back to the high energy, high impact, high reward environment of a nimble emerging software company.

During his first week on the job, Jim comes into your office and says “Given the potential customers you have circled, my existing relationships, and the company contacts my new sales team will have, I think we could have a pipeline of over 100 potential clients for the new platform. I am sure we can nail a high percentage of these prospects but we have to be really careful that we don’t over promise and under deliver with respect to certain key things: (1) delivering on the functionality that we sell and the capabilities of the software, (2) the time to implement and expected “go-live” with the full functionality, (3) the stability and up-time of the new system particularly given that we are delivering it on a SaaS basis, and (4) the cost with respect to the core system, implementation, on-going maintenance, and any upgrades. If we don’t stay “on-it” with respect to these things from the start, we will have some very disappointed customers – a bad thing for a new software business.” You respond, “Jim, thanks for the heads up. I definitely agree we have to track and hold the team accountable in those areas. In addition, we have other critical things to measure: (1) Pricing and profitability of the new system and the additional modules we are building, (2) Utilization and efficiency of our services and implementation teams particularly given that every implementation will be different, (3) Detailed sales pipeline tracking, (4) The true cost of development and the product roadmap as well as the cost of maintenance, and (5) Making sure everything syncs up with the annual budget and multi-year plan. All that and we have to track some of those things on a weekly even daily basis.”

As Jim walks out of your office, seemingly satisfied that you understand the importance of his concerns, you contemplate how your CFO is going to handle the new demands. Historically, your management reporting consisted of reviewing the existing key customer projects, progress with the handful of new client prospects, and the P&L and Balance Sheet from the accounting system. The CFO’s world is about to change dramatically.

Business Intelligence level management reporting systems drive forward looking vision, educated decisioning, and accountability. Business Intelligence looks forward through the learnings of the past.

Too many companies view management reporting as printed financial statements and spreadsheets with sleep provoking commentary about how one line item went up or down compared to prior history or budget. In those unfortunate scenarios, 80% of content describes the past leaving the executive team and Board to navigate the ocean ahead through a hazy fog (whether they know it or not). Big opportunities and challenges appear quickly in the company’s field of vision and the organization has to react before the full impact on the business is completely understood. A company that strives for business intelligence level reporting will maximize the clarity of how future events – new strategies, big customers, new products, acquisitions, etc. impact the company, its business model and its prospects.

OK, what does Business Intelligence (“BI”) level reporting mean? We could debate the specifics, but at a high level BI reporting takes the myriad of data about an organization and its sector (financial, operational, industry, etc.) and distills that information into communications that clearly present the most critical components of business performance and makes recommendations for actions in a way that drives effective management decisioning. I know, that sounds like a bunch of management speak – Here is one simple visual example:

With BI level reporting, the 2010 financial forecast evolves from a sea of numbers that only finance types can wade through into a usable document that raises fundamental questions about the business and drives management decisions. The above should also include commentary that provides insight on the implications of the data and makes recommendations for action. This example was pulled from an actual 2010 budget for a mid-sized company.

How do you build BI level reporting?

• Work with each business unit (sales, marketing, development, production, CEO, Board etc.) and agree on the key business information and frequency necessary to track day-to-day, quarter-to-quarter performance and progress on key business unit milestones.
• Determine how best to produce this information given the existing IT and accounting / finance infrastructure – strive for maximum automation. Scope out any necessary changes to current IT systems required.
• Work back from the key milestones and prepare reports, dashboards and KPIs that will measure performance and allow you the lead time to make corrections if things aren’t going as planned. Strive for conciseness, clarity of message, and a dashboard mentality.
• Build the company’s budget based upon running out the key milestones, metrics and dashboards (new vs. existing customers, price / volume, development roadmap, utilization, staff efficiency, etc.) so that the business units understand the budget in terms of their day to day performance and tracking.
• Determine other critical information that the team needs to understand the levers of the business – profitability by product, customer, business unit, geography; key trend lines; major potential initiatives that might not be budgeted, etc.
• Leave capacity for the ad-hoc analysis and reporting that will certainly come up – “Customer X wants this additional unplanned functionality”, “There is this huge deal in Germany - how should we price it and how long will it take to implement?”, “If we moved 20% of our development to India, what would be the impact?”, “If we raised an additional $10mm, how much faster could we grow and what would the business look like in 5 yrs?”.
• Take the time to get behind the numbers and communicate clearly – do not just prepare spreadsheets and dashboards and distribute them. It is the role of finance to understand what the numbers tell the organization about the business and communicate that clearly to the team – many of whom look at a spreadsheet and get lost in the detail. Insightful commentary that accompanies the dashboards and reports will keep the team engaged and focused.

As you can imagine, the above bullet points, which are not all-inclusive by any means, represent a ton of effort. Effort required not only of the F&A staff, but of the business units and the executive team. That said, if automated properly, once built any changes should update the entire management reporting package and dashboards with minimal effort. When combined with insightful analysis and recommendations by the finance organization, the entire management team becomes “students of the business” and has clear visibility how best to achieve its goals and how to react when unanticipated opportunities and challenges present themselves. Additionally, the F&A function becomes a critical strategic function, not just where they “count the beans”.

BI should be transformational. Properly executed, the entire management team should have the tools to understand the most important levers to pull to maximize business impact, have information when it is actionable, be able to communicate complicated information clearly to non-finance types, and be able to openly debate the best course of action. Without that, not only will the company’s view of the future be foggy, it could be blind to the implications of very important opportunities or obstacles. (The link below shows that nicely.)

-Bob

Click here to see a video of what can happen if your visibility isn’t quite clear; http://www.youtube.com/watch?v=-9vrD5dmPms

RAISING MONEY (Finding the right partner) - Business Tactics (second in a series)

image from the NSCD

Situation (continued from prior post): After you and your fellow founders spend much time brooding over the pros and cons of raising money to build the product suite vs. bootstrapping it, debt vs. equity, etc., you decide to raise $4mm of growth equity capital. At the end of the day, the decision hinged on (i) the opportunity being just too great to raise only a small portion of it (inquiries from the key clients have intensified recently), (ii) timing – you are a bit concerned that another web / software company may get to market first, and (iii) the somewhat risky nature of the project that makes “putting up the company” as collateral for a bank loan outweigh the lower cost of debt financing.

Over the subsequent weeks, you prepare a presentation on the industry and the business, what you have done, the milestones you need to hit to succeed, the team you need to build, and what the numbers look like. You also built a highly detailed monthly financial plan that clearly forecasts the key drivers of the business and the dashboard that you will use to measure your performance against that forecast. With that material, you speak with several dozen potential investors – most of which are venture funds, although a few strategics are interested in tracking your development.  After several rounds of preliminary diligence, you have received letters of intent and term sheets from several VCs.

Two of the firms, ARB Ventures and Operating Growth Ventures (OGV), stand out from the pack. ARB has an impressive track record and has been around some of the biggest software / internet success stories in recent years. ARB has a large fund and at $4mm, the investment in your company will be by far the smallest in their portfolio. The partners are a bit on the arrogant side and at times are not the best listeners. They have spent the least amount of time digging into the core business, the numbers, and the milestones. That said, the pre-money value of their deal is 33% higher than all other term sheets. You know the devil is in the detailed structure of the security, but that valuation difference is meaningful to you and your partners. Contrasting ARB, OGV has been around for many years and, while it has had some significant success during its life, it has stayed away from raising larger and larger funds. OGV tends to stick with industries and technology that it knows well and does significant diligence on every investment. Their list of preliminary diligence requests was almost overwhelming, but in all conversations with them, it was apparent that they fully analyzed all information provided and had a strong grasp of what the company had to do to succeed. The partners were calm, listened well and were genuinely interested in the intimate details of running the business. Further, through its LP network, OGV has deep connections with a dozen key potential customers of this new product line. While nothing is assured, they could help grow the business in many unique ways. Unfortunately, OGV’s pre-money value of the business is in the middle of the pack. Each firm wants an exclusive to move forward – who do you go with?

Find the partner that truly brings operating benefit and maximizes likelihood of success – that is more important than getting a higher early round valuation.

Valuing private businesses is not an exact science. While much complicated and not so complicated math, diligence and research can be employed to come up with values, virtually all of it is based upon different expectations of the company hitting certain performance hurdles over the coming years. In most cases, differences in initial valuation (and the “paper” value to shareholders implied in higher valuations) when the company is young can become moot when compared to the long term value added of the right investor. The investor that brings true operating expertise (as opposed to just words), industry contacts, access to key executives, and reasoned counsel at the Board level can bring long term value to the Founders and existing investors that can far exceed initial valuation differences.

Here is a simple example (using the “Situation” above as a guide relative to size and numbers): Suppose ARB proposes investing $4mm to purchase 20% of the company vs. OCV proposing $4mm to purchase 25%. The implied pre-money values are $16mm for ARB and $12mm for OCV, or $4mm (33%) more “paper” value to the existing investors at close under the ARB deal. That is an unusually large valuation discrepancy for a business of this size. Offsetting the higher ARB valuation, you believe that OCV would truly add operational benefits over ARB given their industry expertise, contacts, knowledge of the business drivers, and their reputation of being a respected advisor to portfolio companies. While difficult to quantify, you believe that OCV could increase the likelihood of hitting or exceeding your plan by 20-25%. Using different discount rates as a surrogate for increased likelihood of success or reduced risk to the plan, if OCV reduces the risk of the plan by 20% (ie. a 20% discount rate vs a 25% discount rate), then you and your existing investors are better off in today’s dollars going with OCV. Here is the very basic math:

  

 

While the above example simply shows that a lower discount rate means higher value today, something we learned in college, it illustrates the importance of having a group of investors and Board of Directors that add operating value to the business. Different investors / partners bring different operational value with the best ones maximizing the likelihood of success.

Here is a list of what I believe are the most important things to cover in choosing the right investor:

Do they bring value other than money? Almost all firms will talk about how they are really operators and bring incredible value to their portfolio companies. Your fiduciary responsibility to your existing shareholders is to cut through the words and slideware and do your diligence on the investors. You need to determine how real that value added is. It should be tangible – past experience / learnings from investing in the industry, customer / industry contacts that drive revenue or reduced cost, direct operating experience that improves the business, technical expertise that improves the product or the way the company approaches development, QA, BCP, access to strategic partners that can expand the breadth of the business, etc.

Do your diligence on them. Speak with executives from their current and past portfolio companies. Understand how they act as Board members – did they stay up to speed on the key business drivers and industry dynamics? Did they provide strong and relevant counsel? Did they really deliver on the “operating benefits” that they sold prior to funding? How did they respond and help the business in tough times? Did they communicate regularly with the CEO, or were they only engaged around quarterly Board meetings? Were they really “long term” investors like they said prior to close, or did they push for a quick exit.

Are they on the same page strategically? Do they share your same view of not only the direction of the industry and the opportunity, but on the major components of the company’s growth strategy and the tactics of how to get there? How deeply did they diligence your business, the way you manage it, how you set and track milestones, your technology / the application(s), your development methodology, how you go to market, how you will measure success, etc. While it is a bit obvious, the right long term investor will have done their homework, gotten intimate with all aspects of your business and success drivers, share your strategy and agree with your tactics.

Past investment success in your industry. How deep is their experience in your sector / industry? How successful have they been with their past and current investments? As you look at their portfolio, does your company fit well within an overall fund strategy or does it stand as an outlier – in a different sector, in a new market / channel, much earlier or later stage (revenue size, cash flow), a much smaller or larger investment, a different control position? Being different is not necessarily a bad thing, it could be a very good thing, it just is an additional data point you need to consider that could reflect how they might act as an investor / Board member in the future.

Is there a cultural fit? A bit of an intangible, but a cultural fit with your key investors is critical. You will likely be spending a ton of time with them over the coming years – figuring out how to capitalize on huge opportunities and hashing through tough problems. You don’t have to be best friends, but there has to be a mutual respect, complementary communication style, and shared passion in the business. Importantly, both of you – the investors and you as management – have to be good listeners. Having mutual respect and listening to each other is the best way to maintain a constructive dialogue and ultimately make the best decisions for the company.

How to get the most out of your investors / Board:

Make sure the Board and the new investors look at the business and measure performance the same way the management team does: Everyone needs (i) to be on the same page as to how success is defined – short term, medium term, and long term, (ii) to agree on the key business milestones that will drive that success, and (iii) to get information on a timely basis. Not only will it focus all of you on the right business drivers, it is the difference between reporting and analysis as “business intelligence” vs. plain old financial statements. That isn’t to say that the Board should get the same reports that management uses to run the business, but the Board reports should highlight the same key metrics the management team is using to track itself.

Build a financial model / business plan that is detailed, forecasts the key business drivers, sets forth the milestones that will determine success, and communicate progress clearly and often. The financial model upon which success is based must be highly detailed so that it reflects that true drivers of the business. Take the core fundamentals that you track on weekly / monthly / yearly basis and drive those out several years: number of clients, existing vs. new clients, seats of the product sold, price per seat, hours of consulting, development hours, staffing needed to drive that growth, hardware & equipment needed to support that growth, etc. The detail doesn’t need to result in a 50 page financial model, but it does need to be detailed enough to allow you and the Board to track progress on the key milestones and to manage the likely variability of the business. Among many other things, you need to understand clearly the revenue implications of more or less investment and the cash implications of more or less revenue.

Set performance goals that are a big stretch, but realistic – then do what you say you will do.  Anyone that invests in or runs growth companies is highly goal oriented. The rush of excitement and accomplishment of building something from scratch or taking an organization to the next level is addictive and contagious. It is why we do this and it is why we can attract talented staff and sophisticated investors. That said, it is difficult to build a “winning culture” and achieve great things without a foundation of credibility related to goal setting and measuring and rewarding performance. That foundation requires that you set goals at the employee level, at the business unit level, and at the company level that stretch the organization well beyond its comfort zone but allow for frequent “dancing in the end zone” when milestones are achieved. Setting unrealistic goals erodes management credibility with investors, the Board and staff and ultimately damages company morale, resulting in a culture of disappointment rather than a culture of success.

View your investors and the Board as partners and advisors – not just groups that have funded your plan. If you have built your business to a certain level, you know that you don’t have all the answers and you need to rely on trusted advisors. (I believe the most successful C-level executives subscribe to the “Dirty Harry School of Business” – ie. Know your limitations. Therefore they surround themselves with smart people and seek constructive input freely.) This requires that you have open lines of communication with your Board. While it is still your responsibility to run the business day-to-day, you should set up regular informal and formal communication. Use them as a resource – after all, you sold them a portion of your precious business – make the most of them. Squeeze as much value out of them as you can. That will require you to keep them updated frequently on the progress of the business and let them know about good things and bad things before you have had full opportunity to determine a course of action. If they are the right investors and there is mutual respect in each other’s skills, then this should not be a problem.

Final words

OK, so you have decided to sell a portion of the beautiful business you have created. From the beginning you have been focused on building the company for the long term – don’t let potentially ephemeral “paper” value at one point in time prevent you from bringing on the investor / partner that adds the most value over the long term. Make sure that investor does their homework before close, understands the drivers of the business (and things to avoid), brings significant operating value to the core business and is a trusted advisor that you respect. If you then set stretch goals (not unrealistic ones), make sure everyone is on the page with respect to strategy and tactics, provide access to key information and intelligence about the business and its progress, and have open communication, then you should be able to get more than your money’s worth from the new investors.

-Bob

A couple funny examples of how having the wrong partner can be a problem.

http://www.youtube.com/watch?v=m5gCbvfw0T4&feature=related

http://www.youtube.com/watch?v=QTBAEcTNgNU&feature=related

RAISING MONEY (When do I do it) – Business Tactics (first in a series)

Situation: Over the last 5 years, You and your partners have built a nice sized internet services business – web design, e-commerce infrastructure, SEO, maximizing and managing social media, etc. for large to medium sized businesses. The business now employs about 30 people handling several dozen projects and you have gotten some nice recognition in your local market. Given the service / “pay by the project” nature of the business you have been able to fund the business with very little capital other than the sweat equity you put into it during the first year.

On three of the most recent projects, the clients were asking for similar web activity tracking functionality. They were not easy projects and took more time than usual, but the ending functionality was pretty impressive. As part of building out the functionality, you realized that it could be possible to build a software platform that accommodated those client requirements and more with the ability to plug-in additional functionality through future software modules. You estimated that it would take a group of 6 experienced software developers about 18 months to build the platform, document all the requirements and processes, map out installation and conversion protocols, and set up a roadmap for future modules. Additionally, you would need to build a small maintenance and support team, as well as potentially hire a software sales staff (you need your services staff working on existing projects and doing the installations and conversions.)

You are pretty excited about the prospects – you know several dozen large clients that would likely buy the platform and be great references for you as you build out this new business. You are also very tempted by the huge potential revenue growth that a software business unit could generate, revenue acceleration you would never get if you stayed as a services company. That said, the added investment in staff, technology and equipment would require you to raise $4 million just to get the product launched and the maintenance and sales teams put in place. After that it is likely you will need additional capital if the platform takes off. You don’t have the money, but you know half a dozen venture firms that you could approach. That said, raising outside capital means two things – (1) significant dilution and (2) someone else has a say in the business. Your two biggest fears. What do you do?

Maximize the likelihood of success - Don’t be afraid of dilution or outside opinions. Focus on valuation (cost of capital), the strength of the partner (what they bring beyond money), and hitting key milestones (doing what you say you will do).

One of the main reasons many young companies fail is that they are under-capitalized. Being under-capitalized doesn’t just mean a lack of cash in the bank to cover normal operations. I define it as “lacking sufficient capital and capital sources (i) to weather anticipated and unanticipated changes in the market (changes in the competitive dynamics, changes in the economy, changes in client needs, etc.), (ii) to capitalize on market opportunities that will require investments in staff, production capacity, product development, new markets, new business units, etc., or (iii) to fund normal operations over the long term.”

Great ideas and businesses need capital to develop and grow. In many young companies, that first capital comes from a Founder, friends and family, and business acquaintances. These early investors typically have a passion for the product / service and work closely to help the company grow. They have personal stakes in the business, financially and emotionally, that they protect dearly – sometimes to a fault. Assuming a company gets through the minefield of problems that confront the emerging business and is able to carve out a niche, land clients and build a viable business model, it often arrives at a crossroads…..

“Do I keep doing what I am doing and grow at X rate given my limited capital and cash flow, or do I bring in new money to capitalize on an opportunity, defend my market position, and accelerate my growth?”

In many cases, making that acquisition, building that new product, expanding production, hiring a new team, etc. requires capital a company does not have on its balance sheet. Some companies can borrow, some have to raise equity (sell a portion of the ownership), some have to do both. At that time, the company is forced to look at its business, the markets, and key milestones, etc. and weigh the benefits and cost of staying the course or bringing in new capital. Often the following thoughts go through a Founder / CEO’s mind as they wrestle with the above question:

On the “keep doing what you are doing side”:

“Bringing on debt at our stage adds a level of financial risk I am not comfortable with.”

“I won’t have to give up any ownership – I don’t want to be diluted.”

“Under the current market conditions I don’t think a new investor will pay me what I think their stake is worth” or said another way, “I would rather sell equity after we reach the next business milestone which appears to be right around the corner.”

“New capital will mean I have less control over the business, and I am not sure I trust VCs.”

“We are cash flow positive now, growing and investing is risky, particularly if we start burning cash again.”

“If I just tweak what I am doing now, I might be able to slowly invest in the growth opportunity and not have it distract the rest of the business.”

“I really don’t care that much about growing large – staying mid-sized still allows me to meet many of my personal goals.”

“Instead of making that acquisition, we will build the product / functionality ourselves.”

On the “bring in new capital side”:

“I will be able to capitalize on a major market opportunity and accelerate growth.”

“Competition is intensifying, new capital and a new partner will allow us to stay ahead of the game.”

“I will be able to bring in expertise that I need to take the business to the next level.”

“I will have a deep pocketed partner that can help me navigate uncertain business and financial waters.”

“I will have a partner that can introduce me to business people and opportunities I would not have access to otherwise.”

“I am OK with having a smaller piece of a potentially bigger pie, particularly if it increases the probability of success.”

Many owners / founders struggle with the concept of diluting their ownership stake, and naturally, the price that stake should be worth. While price and value are critically important and determine the amount of dilution, I contend that the struggle around dilution as a concept typically gets more focus than it deserves. It is the responsibility of the owner / founder / CEO to maximize the value of the business for all stakeholders. While bringing on new capital will dilute the various ownership stakes (dividing the company pie into more pieces), if done properly and with the right new partners, that capital should significantly increase the likelihood of success and ultimately make the ending pie bigger than it would have been in a capital constrained position.

In considering new capital, focus on three things: (1) make sure the cost of that capital is “market”, which may require you to hire an advisor to assist in valuing your business and comparing different sources of capital, (2) make sure you are bringing in the right partner - a partner that brings in more than just money, and (3) have an intimate understanding of the business milestones you need to achieve and how you are going to achieve them once you get the capital. Most of your energy should be spent on those points and you should spend a ton of time on them. If you come up short on any one of these points, you risk permanently damaging the business.

There are many examples of companies that ...

-Tried to build the software business on their own and missed an opportunity because it took too long;

-Didn’t bring in the capital necessary to hire the best developers in the business and struggled with product quality;

-Didn’t have the production capacity or working capital financing when the “tipping point” actually happened and they got massive orders from their top 4 prospects that they could not fill;

-Didn’t invest heavily enough to grow the business when they had a competitive advantage and now they are being marginalized as the big competitors come into the market with big balance sheets;

-Chose a partner that eagerly invested money at a great valuation, but didn’t understand the business and rendered decision making ineffective;

-Did not raise money when the capital markets were vibrant because they didn’t need the money for another year, only to see the markets freeze up and access to money disappear;

-Set overly optimistic goals or poorly thought out milestones in the desire to get a maximum valuation, only to significantly underachieve expectations and then lose control of the business.

Avoid being in this group by seeking partners (those with money and those without) that can best help you navigate evolving client / consumer needs and a dynamic competitive environment. Critically evaluate opportunities to grow your business, the milestones you need to hit to capitalize on those opportunities, and the money it takes to get there. Also recognize that capital isn’t always easy to access at the precise moment you need it – “raise it when you can, not just when you need it” is a good mantra to follow. If a certain opportunity or competitive situation requires that you raise money, make sure you thoroughly assess the costs and benefits of different kinds of capital. That may require you hire an advisor. Once the cost of that capital is reasonably known, focus more on how that partner is going to help you grow the business beyond just giving you money and less on the fact that you will be diluted and have someone else to whom you need to listen. Lastly, set realistic stretch goals for the team and create opportunities to ring the “success bell” often. If you do that, you will have then maximized the likelihood of success and be asking the right question - “How big of a pie can we and our new partners create?”

-Bob

Click here to see a great video of exactly how to plan for the right partner (you will want to pass this around)

KNOW YOUR BUSINESS AND BRAND DNA – A Key Fundamental Business Tenant

Ask the following questions of yourself, your business, your organization:

At the absolute core….

     What is the reason you do what you do and what are you trying to accomplish?

     What is the need you are trying to fulfill?

     Why do your clients / customers purchase your products and services?

The answers to these (and other) questions determine the DNA of your organization. Why it exists, why customers buy the product / services, why employees work there (why the good ones stay), and why you will be successful over the long term (assuming you have a viable business model).

You should be asking yourself these questions when you are formulating your idea, in Year 1 when you are frantically accumulating customers and refining the product / service, when you are raising private or public money, when you are the largest in the market and others are copying you. While this might seem obvious, I believe most organizations focus on this only when starting up, or when compelled by new management, owners, or a change in brand strategy.

As a leader / founder, it is critical that you decide what parts of your original vision and mission for the business are “sacred” and what others can and should evolve as the market changes, as your consumer’s tastes and needs change, and as your business matures. In that way, your organizational DNA lives and grows yet stays true to a fundamental vision or ideal. The successful company must observe what its customers and employees are doing through the lens of its core mission and goals. You should then evaluate whether your current practices or any major project you are considering are consistent with and therefore reinforce your core DNA, or confuse people as to what you really are.

If you are not constantly evaluating how your messaging and business practice reinforces your DNA, you run the risk of gradually losing focus on the core reasons you exist. As mentioned in the Focus posting, the biggest challenge to most growing organizations is not finding ways to grow, but managing a myriad of opportunities that present themselves. This isn’t just the “Don’t go international yet”, or “Don’t launch that new product yet” lesson, it gets to the basics of your core product / service. You need to be intimate with your DNA and stay disciplined to know exactly how to describe your core product / service, how to position your product with your customers, how to communicate your competitive differentiation, and how to build corporate culture with your employees. 

Let me highlight an example of a great company that I believe has lost sight of one part of its DNA as a result of extraordinary growth:

Starbucks: I needn’t highlight the meteoric growth of Starbucks as a business. In short, the company was started in 1971 when three academics opened the first café in the touristy Pikes Place market in Seattle. The goal then was to give consumers (i) the best cup of coffee possible at the store, and (ii) supply them with beans so that they could brew excellent coffee at home. By 2009, Starbucks had grown to over 17,000 stores in 49 countries and almost $10 billion in revenues.

Clearly, moving from an artisan coffee shop to 17,000 stores around the world requires superhuman vision, discipline and flexibility. To his credit, Howard Schultz (who joined in 1982 and ultimately became the CEO that drove its growth) was intensely focused on maintaining quality, culture and mission as well as being a remarkable visionary. (The Founders originally only wanted to sell beans – Schultz pushed to get into the beverage business.) But even with his focus and commitment, meeting customer expectations of (i) super premium quality and (ii) not having to wait more than 3 minutes for a cup of coffee and investor expectations of constant double digit profit growth, proved very difficult. I will not review the various machinations of Starbuck’s growth strategy – selling music, expanded food menu, ice cream, etc. there are others that have done far more work on that. What I will ask is “What is Starbuck’s DNA?” and “Are its current mission, strategy, and actions in line with its DNA?”.

Starbuck’s DNA: How would you answer the three questions at the top if you were on the Starbucks’ Board of Directors? Here is how I would answer them:

What is the reason you do what you do and what are you trying to accomplish? Starbuck’s goal is to improve people’s lives and benefit communities by providing the highest quality products (mainly coffee) and a retail environment that facilitates community and business interaction. (Note that these are actually two very related but different business ideas.)

What is the need you are trying to fulfill? Consumers desire a high quality coffee beverage as part of their daily routine and enjoy having a quiet place to interact with friends and business acquaintances. Other options are either lower quality or non-existent.

Why do your clients / customers purchase your products and services? Thanks in large part to Starbucks, consumers now appreciate a high quality cup of coffee and are willing to pay premium prices for it. That said, at $3-$4 per cup, quality is everything. There is clearly a convenience factor and certain consumers will trade off quality for speed & convenience. These needs (quality vs. convenience) can conflict. Additionally, Starbucks is a great place to meet because there is always one close, it is relatively inexpensive space (only requires a small purchase) and the atmosphere is highly conducive to interaction.

Starbucks’ original mission (ca. 1982): "To establish Starbucks as the premier purveyor of the finest coffees in the world while maintaining our uncompromising principles as we grow." One interesting quote from Founder Jerry Baldwin: "We don't manage the business to maximize anything other than the quality of the coffee." In 1991, the Los Angeles Times named Starbucks as the best coffee in America.

Starbuck’s new mission as of 2008: "To inspire and nurture the human spirit - One person, One cup, and One Neighborhood at a time." The mission then sets forth how the company pursues this mission through its Coffee, Partners, Customers, Stores, Neighborhood, and Shareholders.  (See the links below.)

My thoughts: Both missions are admirable and aspirational. In my view though, I believe the demands of meteoric growth have forced Starbucks to sacrifice the quality of its product (the DNA expressed in the original mission ) for speed and convenience. Recall, if you can, back in the early 1990’s when Starbucks actually was the best coffee one could reasonably find without a trip to Italy. Whether it was drip coffee or a fancy espresso drink, quality was everything. Again, at $3-$4 dollars a cup, it had to be. Quality takes time, patience, attention to detail, training and costs money. Over the years, convenience, speed and efficiency took precedent over taking the time to brew the coffee perfectly every time, get the foam just right, or really understand the difference between the various coffees in the store. What is interesting is that due to the pressures of growth (opening more locations, driving more volume through the store, etc.) Starbucks trained the consumer to value convenience and speed over quality. When one used to require a perfect cup of coffee for $3-$4 dollars and was willing to wait, one is now willing to pay the premium to know that there is a store within 300 yards and one can get a caffeine hit in less than 3 minutes.

Starbucks now competes based on convenience and speed (and price) rather than quality. The result is companies that also specialize in convenience, speed and price soon become competitors – See McDonalds, 7-Eleven, Dunkin Donuts, etc. Obviously this is a massive “red ocean” of competition (in marketing parlance) that I believe puts Starbucks in a vulnerable position long term. That said, this opens the door for other more nimble companies to grab the quality positioning and steal consumers – See Blue Bottle, Espresso Vivace, Gorilla, and Ninth Street (frankly, Nespresso makes an infinitely better coffee and it is owned by Nestle).

So… Decide which components of your vision / mission are “sacred” and listen to the market, your consumers and your employees – get intimate with your DNA. Then make sure all activities from sales and marketing to new product development and employee hiring reinforce that DNA. If you do that, you might sacrifice some near term growth opportunities, but consumers will know what you stand for and you will build a healthier organization and stronger brand over the long term. Otherwise, your long term future may be at risk.

-Bob

Some interesting Starbucks reference documents:
http://www.mhhe.com/business/management/thompson/11e/case/starbucks.html
http://en.wikipedia.org/wiki/Starbucks