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bi-weekly column with timely,
relevant and possibly irreverent
insight into the BC technology
industry.
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Something Ventured:
April 13th, 2007
By
Brent Holliday
Greenstone Venture Partners
Black Cats And Blown Budgets
“Some folks are born
Silver spoon in hand,
Lord, don't they help themselves, oh…
It ain’t me, I ain’t no fortunate one, no”
– Creedence Clearwater Revival, Fortunate Son
When you write a column for Friday the 13th,
the topic has to relate to luck. To some this day has
enough negative feeling that they want to stay home,
wear protective gear, hide in a dark room and watch “the
Secret” DVD over and over again to ward off negative
energy. I am a believer that you make your own good
luck by working hard and being prepared for anything.
But, bad luck does happen. Not necessarily after you
walk under a ladder, cross paths with a black cat or
break a mirror. That is just coincidence rather than
causality. Of course, having a rabbit’s foot or four
leafed clover can help reverse all of that bad karma
right? No one knows this better than the start-up
entrepreneur, especially when making predictions,
forecasts and budgets.
Venture capitalists have the “good” fortune of having to
review hundreds, if not thousands of predictions of vast
wealth in the form of business plans and their
associated financial models. Once invested in a
company, every VC will tell you how very few of the
predictions are ever met, even after adjusting them
down. Many of the burning questions that all
entrepreneurs ask constantly revolve around the
expectations set with financial forecasts. Do VCs
discount all forecasts? Does it hurt my chances of
raising money to be conservative/realistic in the
forecasts? Do I get fired after raising money based on
the forecasts and then fall short?
On this day that celebrates bad fortune, I thought I’d
lay out a couple of the common themes around making
financial predictions, having them fall short and what
to do about it.
Boundless Enthusiasm And The Pro Forma Statements – If you don’t have some sort of naiveté about what you are getting
into when planning a business, then you won’t ever get
started. So I shouldn’t snicker at the forecasts in
business plans and executive summaries that predict a
company will have $100M in sales in five years… from
scratch… with a new product… and a “wet behind the ears”
management team. If the team does not believe they have
the best thing ever, they won’t go for it in the hell
bent style that a technology start-up requires. Of the
gazillion new businesses formed every year worldwide,
about one each year will reach $100M in sales in its
first five years of business. Those are long odds.
I’ve said this before: The investor looks at the
business model (profitability on a unit basis) and then
tears into the assumptions behind pro forma financial
predictions. If the assumptions are validated and the
model makes sense, then there are really only a few
million variables left to de-rail the plans. Those few
million variables are known as risk. Management risk,
technology risk, financing risk and market risk make up
the buckets that an investor will investigate in the due
diligence phase before making an investment.
So, wild-eyed numbers in the plan are OK, if the
underlying assumptions make sense. $100M in sales in 5
years is unlikely, but the business may have that
potential in 10 or 15 years which is not a bad outcome
for the entrepreneur or the company that acquires the
business on its way to $100M.
Don’t send a plan to an investor that has you reaching
$5M in sales in five years either. If the underlying
assumptions in such a case are showing that you won’t
own a huge chunk of some market and that the market
itself is large and growing, you won’t get investors
excited.
Budgeting Disasters And The Credibility Problem – As I just stated, the business plan can be forgiven for
being outlandishly optimistic. But when the investment
happens and shareholders are now part of your world,
things change. This is the downfall of many a founder
CEO. The naiveté and boundless enthusiasm that leads to
a business being created and funded is the Achilles Heel
of creating and making budget. They can’t help
themselves from trying to make the numbers that they
sold to investors. Investors need to help here and
realize that more achievable numbers means more positive
energy around the business. They need to let the
entrepreneur know that the budget needs to be realistic.
There are two types of start-up budgets. One is the
expense budget where the company is so early that it is
only spending money as it develops product and meets
milestones leading to further funding. This is a tight
budget and easier to make happen. Spending can be
directly controlled by management. Missing budget at
this stage in the company is almost inexcusable. The
other type of budget is the regular revenue/expense
budget of a company with sales. Predicting sales is the
toughest aspect of any start-up as there are no examples
or history to show how and where you grow your top
line. It is almost like throwing darts and success in
meeting targets is directly correlated to how far out
you are predicting. Next quarter is easy if you have a
sales funnel. Four quarters from now is just plain
fanciful.
How many of you have been through the budgeting exercise
where the growth is decent in the first two quarters,
but in order to make the year, the third and fourth
quarters have significant ramp? Oh c’mon, we all do
it. We assume that the systems and processes in place
in the first six months (people trained, partnerships
established, etc.) will lead to great gobs of sales in
the second half of the year. Unfortunately, you, as
management, are just setting yourself up to fail. Any
delays in hiring, partnerships, supply, lead generation,
etc. will push your growth out a few more quarters.
Welcome to the “revised budget”!
If you miss your top line, investors want to know why.
On the first one or two misses, your response to the
reasons that you missed are the critical management
functions. How will you change things? Where will you
get more sales? What expenses will you adjust to help
make the cash or profit number? Your entire credibility
as a manager is not lost on the first miss. If you fail
to fix the reason for the miss and you miss again and
again, you are done. Toast. You will have lost your
investor’s confidence.
Set your budget up for success. Curb your enthusiasm
for wild growth when planning your budget. Exceeding
budget is a rare thing in a start-up. It gives
investors goosebumps.
Back to the theme of luck… Any veteran CEO will tell
you that all the planning and processes and execution
can get de-railed by external factors beyond the
company’s control. Competitive forces can be analyzed
and planned for, but plain dumb luck can ruin a
perfectly good budget. Supply disruptions because of
rail strikes. Recession in the global economy. Key
sales person gets cancer. Bad stuff can happen. You
can’t dwell on it. You have to make do in the
environment that is given to you. If something bad
happens once, you are easily forgiven. If you are
reporting to your investors/shareholders a continuing
string of bad luck, your credibility might suffer. Make
sure you are not doing a feint of hand and trying to
cover your bad hires, poor management or weak execution
with stories of external “bad luck”. That’s simply
passing the buck.
There is good luck out there too. Your chief
competition can get embroiled in a scandal. A new
customer can appear out of nowhere with a huge order.
Oprah can recommend your product on her “giveaway”
show. Every successful company can point to a key piece
(or pieces) of good fortune that accelerated their
growth.
Good luck in predicting your company’s future. I truly
hope that you exceed expectations.
What Do You Think? Talk Back To Brent Holliday
Something Ventured is a bi-weekly column designed
to supplement the T-Net British Columbia web site with
some timely, relevant and possibly irreverent insight
into the industry. I hope to share some of the
perspective and trends that I see in my role as a VC.
The column is always followed by feedback (if its
positive or constructive. I'll keep the flames to
myself, thanks).
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