Aug 4 2005

Meeting The Numbers

Fred Wilson has a great weekly series called VC Cliche of the Week – this week’s post is on meeting the numbers.  It’s worth a slow and thoughtful read.

I have one constructive thought to add.  I’ve been involved in over 100 startups at this point and have seen many more.  I can only remember a few instances where the company exceeded its revenue numbers in its first year of product ship.  Many companies make their expense, EBITDA, and cash forecasts by adjusting spending, but that’s fundamentally different than making the top line and the bottom line numbers early in the life of the business (again – let’s focus on year 1 of product ship – not after the company has had several years of products in the market.)  I’ve found that for year 1, the correlation between the sales plan and reality is completely random. 

As a result, I generally take a different approach to year 1 of sales / revenue.  Rather than hold a company to a revenue plan in year 1, I try to focus on the cash spend in year 1 (Fred highlights cash flow as the “ultimate measure” – and focusing on managing the negative cash flow is equally effective as managing the positive cash flow.)  An early stage company needs to spend a certain amount to make progress, but managing the expense line should be straightforward.  As revenue comes in (especially high gross margin revenue), it becomes easy to step up the spending, especially on variable cost (more demand generation) or highly leveraged items (more sales people) that impact future sales.

This tends to be a continual, iterative process – I’ve had cases where revenue starts accelerating later in the year, at which point the spending increase starts.  If you use the fiscal year as the measurement, the annual revenue number is missed, but Q3 or Q4 revenue may be greater than plan. I’ve also had cases where the revenue mix results from various product “types” (or “editions”, or “versions”, or “vertical markets”) are radically different than the forecast (which often drives the allocation of variable spend.)  Of course, if you wait too long to start investing incremental dollars you “might” miss an opportunity, although I rarely find that to be the case with an early stage company that is spending “pre-revenue” or “early revenue” at an appropriate level.

It’s a complicated dynamic and reinforces a couple of things.  First, management and the board need to have similar expectations about what “making the numbers mean” in year 1 and have to deal effectively with any changes in the top line plan.  This is especially true around expectations of the sales organization (and corresponding comp).  Next, the CEO needs to have “controlled confidence” – there comes a point at which one can confidently say “let’s go for it.”  Reporting and communication have to be timely (e.g. financials within 15 days of the end of the month, monthly board meetings/calls after the financials come out.)  And finally – as Fred points out – management should be honest about the actual numbers at all times – there is never any value in lying or gaming things.