MONEY TALKS by Andrew Waitman

The failure of our venture industry to produce eyebrow-raising venture returns is a failure to discriminate winners from losers at every stage of the venture investment cycle.

WaitmanHighEdit-111X196.jpgThe Elusive Goal
From SCAN's Print Edition

There’s a saying in the VC business that “lemons ripen sooner than plums.” Fruit farmers know that lemons “show” earlier than plums. In the venture metaphor, the lemon among investments ripens (starts to smell) earlier than the plum, which takes time to ripen into a powerhouse. Sandvine in Waterloo received initial seed funding from Celtic House the week before Sept. 11, 2001 and achieved the elusive $100 million run-rate by 2007. That speed of ascension is impressive and rare in any geography, particularly in Canada with many fewer technology start-ups than the U.S. Memsic, a Boston-based Celtic House portfolio company, which has filed an S1 to go public, is expected to take eight or nine years to reach that run-rate. Vixs Systems, a Toronto-based Celtic House seed funded start-up, is expected to get there in seven or eight years. The question germane to a VC is, “How can I know in the early years whether a start-up should be scuttled to avoid wasting more money or strengthened with additional cash to continue its climb to $100 million?”

There are in fact leading indicators that differentiate winners from losers, allowing investors to focus attention and resources where they should be. The failure of our venture industry to produce eyebrow-raising venture returns is a failure to discriminate winners from losers at every stage of the venture investment cycle. Numerous venture investors considered and passed on the opportunity to invest in Sandvine and Vixs. This is telling anecdotal evidence of failed success identification. Portfolios chalk-full of no-growth or slow-growth start-ups suggest a lot of adverse selection.

The first indicator that an early stage start-up is poised for scale success is the skills, experience and drive of the management, employees, board and advisors. In David Thomson’s book, BluePrint to a Billion, he identifies seven elements that are shared by companies ascending rapidly from $50 million to a billion. Companies scaling rapidly had more individuals on the board and management team and more employees with previous experience in building billion dollar businesses. Experienced people generally have better networks, make better decisions and fewer mistakes, so the venture-backed start-ups they start or join have better odds of reaching that $100 million goal. Wael Mohammad, CEO of Third Brigade, an Ottawa-based Celtic House company, has taken Thomson’s insight to heart, recruiting Rob Ashe, CEO of Cognos and Paul Tsaparis, president & CEO of HP Canada to his board.

Every venture capitalist tends to describe his or her management team as “world-class,” a label that has become almost meaningless. Very few start-ups actually have a world-class executive team, if by world-class we mean experienced at building start-ups to $100 million in sales. These people are rare anywhere and rarer still in teams. In my opinion, judging and selecting the founder, management leadership and board talent are the most important determinants of growth and scale outcomes. Backing individuals and teams who are ambitious, talented and experienced in scale will go much further to establishing the conditions to achieve the elusive goal than almost any other element of success. However, other elements do matter.

A second indicator of an early-stage company with scale potential is its track record of identifying and achieving goals and priorities for the year, quarter and month. Though all start-ups miss milestones, those that create a clear path to growth and measure their progress achieve better results than those that do not. It sounds simple, yet few start-ups do it well.

A crucial lesson for start-up boards and management is this: At the start of each year, establish the top three or four annual goals or objectives. Clear and unambiguous goals should be debated, discussed and decided by the entire management team and board, such as:
Raise $15 million of new capital.
Close $5 million in revenue.
Win two referencable, marquee customers with over $1 billion in sales.

Specificity is crucial. From this exercise, the company’s top three or four goals and priorities for the first quarter are established, and then subsequent quarterly goals and priorities. Remember it’s three or four priorities, not ten. Quarterly priorities and objectives are driven by annual goals. Each executive, including the CEO, working within the context of the corporate quarterly goals, establishes her own quarterly goals. These should be recorded and shared at the board level, and once established must be communicated broadly allowing those deeper in the organization to do the same.

The process of establishing goals and priorities cascades down through the organization until everyone understands what his top three or four priorities are to achieve the department’s and, ultimately, the company’s quarterly objectives. This process of engagement, debate and priorities setting should be around goals that have clear deliverables. Avoid ambiguous language like “…during the quarter improve relationship between marketing and sales.” Rather, “establish bi-weekly monthly product review meetings and design review sign-off process.” Companies that establish this rigor not only achieve coherence in the organization, but also adapt better to complex and chaotic market environments. The warning signals of missed objectives can be identified quickly, discussed and debated, and new tactical priorities and goals established. Finally, a third clear distinction between start-up winners and losers is customer traction. Ultimately, achieving the elusive goal is about sales growth. Until a start-up reaches $1 million, it cannot reach $5 million and until it reaches $5 million it cannot reach $10 million and so on to $100 million. Sounds obvious, but the best indicator of future success is past success with customers.

Revenue growth is the validation of all tactics and strategy. Poor revenue growth or sales only to customers that are “cousins and friends” (prior relationships) is an indication that the start-up has failed to identify a flaw in its product, marketing or sales strategy. This is one of the most difficult elements to read correctly because modest sales can be easily misread by investors and executives. Only when a targeted cluster of non-customers have been turned into paying customers can you declare early victory. As patterns of success and failure emerge enabling you to refine your product, marketing and sales strategy, will you establish the conditions and learning for scale success.

There are many other elements that can help separate winners from flat-line losers. In the next column, I will discuss why most due diligence on markets and competitors is, at best, a waste of time and, at worst, misleading and anathema to good investment decision making.
Andrew Waitman is managing partner of Celtic House Venture Partners, specializing in early stage investments in high technology companies.

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