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A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

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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