Look at Acquisitions From All Angles

I was recently coaching a CEO through a complicated analysis of a potential acquisition. An acquisition should make a company more valuable, but it introduces risk and a host of other variables. The calculus involves a broad range of constituents that need to be considered. In addition to all of the financial and legal diligence, it gave me the idea to construct a roadmap, or checklist of softer items to evaluate prior to pulling the trigger on an acquisition.

The first order problem is the decision to move forward or not. From a deal structure perspective, this is pretty well understood territory. There are many good references for diligence checklists, and models to understand the financial implications of an acquisition. However, it is nearly impossible to cover all of potential variables and gotchas in an acquisition. The buyer has to determine what they know with certainty vs what they have been told, what they suspect but need to confirm, and what the likely traps or points of failure are. The unknowns all contribute risk to the deal.

Historic financial performance of the target is fairly easy to interpret, but past performance is not always a great indicator of future performance under new ownership. The seller did not build their business to fit hand-in-glove with the buyer’s business, so there will be rough edges and overlaps that need to be be smoothed out or eliminated. Acquirers look for “synergies,” which is a euphemism for cost savings. The buyer needs to consider the soft side of removing these edges, and how it will impact future performance. Assuming some of the seller’s employees will be reassigned or eliminated as a result of the ‘smoothing,’ what will be the impact on the culture and retention of the remaining employees? Are the effected employees cultural leaders with influence beyond their functional roles, and is there a risk that their exit will destabilize the remaining employee base? It is important to consider the flight risks and the cultural impacts of the synergies.

There are always different ways to structure an acquisition, and each approach will impact various constituents differently. The mix of cash up front, earn out, equity, debt, and timing will lead to different sensitivities. Buyers want to put the risks on the seller, and the seller wants to put the risks on the buyer, so it is a balancing act. If the seller has institutional investors, the buyer ought to be aware of the investor’s fund dynamics. Are they at the end of their fund lifecycle and looking to get out, or is this an under performing asset? Are they open to rolling their investment into the acquirer’s equity stack, or do they want a clean break? I am not a fan of earn outs, particularly as a seller. I view earn outs as a recognition that the two sides do not really agree on price, so they are kicking the can down the road. My frequent quote has been “an earn out is setting up a later fight.” However, as a buyer I recognize that it is a powerful tool to de-risk a deal. It basically means the buyer is unconvinced of the value the seller is claiming, so the seller gets to prove it by performing. The problem is that the buyer will make changes once they own the company, so the business trajectory will not remain the same. Typically the argument will be “you screwed up my company, so we could not earn the earn out.” My advice is to be VERY clear about the buyer’s intentions, the terms of the earn out, and the measures of success, and keep the duration short.

Often, buyers consider the needs of the seller’s employees, but under value the implications for their own employees. Successful acquisitions will typically result in a blending of executives and employees from both companies. There will be overlaps, and there will be winners and losers on both teams. The process will be unsettling for the acquirer’s employees as well as the seller’s. I have a firm rule that the acquirer has to answer four key questions on day-one for every one of the seller’s employees, and any effected employees of the buyer:

1. What is my job in the new company? Job descriptions are ideal, but at a minimum a clear statement of duties going forward is required.

2. Who will I report to? There cannot be any ambiguity of reporting structure. The direct manager is the most important influence on employee retention, so it is vital to set this relationship on the right footing from the start.

3. What is my compensation package? This is a comprehensive topic that includes base pay, variable pay and bonus opportunities, as well as benefits, equity compensation, and vacation or PTO policies.

4. What do I need to do to succeed? Employees need to understand their performance metrics and measures, and they have to believe they are attainable.

One of the most important constituencies is the customer base. The seller’s customers are likely to be unsettled, and if any of them were shaky to begin with, churn can become a huge issue. The seller’s leaders need to be active participants to calm down the base, and the buyer has to allocate senior resources to meet the customers and welcome them. Welcoming means listening, not just talking. Customers want to have a voice and a home with the buyer. Listening will uncover underlying satisfaction issues, and should focus on understanding the value the customers perceive in staying with the new company. It will highlight areas the product team needs to preserve or enhance going forward. This is particularly important if the acquirer intends to retire and replace the seller’s existing product. It is easy to think your product is superior so customers will love it, when in fact there may be some key capability your team overlooked.

The same care needs to be applied to the buyer’s customer base. Often the intention of the acquisition is to broaden the buyer’s product line or capabilities. However, existing customers may see it as deemphasizing the current product and react negatively, or look for a replacement vendor that offers more of a pure-play, where their needs are the only focus for the vendor. Churn is the absolute enemy of acquisitions, so it is paramount to focus on the customers of both companies to ensure the revenue stream is uninterrupted.

There are many other considerations, but the last one I want to address is the need to look into the value of the buyer’s business in the future. Assuming the buyer will either go to market to be acquired, or to raise incremental capital in the future. How will this acquisition impact the timing and the potential universe of future investors? Will it make the company a more desirable target, or will it complicate the future investment landscape? How long will it take to prove value from the acquisition, and is that within the investment horizon of the current owners? Institutional fund dynamics play a role in this decision process. If current investors want to get out in the next couple of years, but the acquisition will result in a short-term downturn while the company builds for a future upturn, will it play out in the timeframe of the current investors? This is particularly true if the acquisition will adversely impact near-term profitability, growth, and churn. It may actually lower the value of the buyer before it raises the value. Current investors may prefer a steady growth path to realize their exit value sooner, and therefore will view the deal unfavorably, or impose performance metrics that change the operating equation post-acquisition. All of the existing investors may not be in it for the long haul.

The bottom line is that the CEO, executive team, and the board need to be aware of all of the implications of an acquisition, and avoid focusing solely on the financial and diligence elements of the transaction. To apply a military analogy, there is the action (doing the deal), the reaction (post-deal fallout), and counter action (what has to happen to make sure things go as planned). As Colin Powell said, “you break it, you own it.”

Take A Breath

I volunteer as a mentor with eForAll, a terrific organization that supports aspiring entrepreneurs to launch mainstream businesses. I was recently on a call to meet a potential mentee who is striving to start a landscape business. He told me that he currently is a one-man company, and he has so many customers for lawn mowing that he cannot devote any time to anything else. He also said that his lawn mower is too small, but he cannot afford a larger commercial mower, and he cannot afford to hire anyone because he does not have equipment for them to operate. He needs a loan to expand his business, but he does not have time to secure one. He is a perfect example of the tyranny of the urgent being the enemy of the important. We talked about his need to take a breath and plot a course forward that will work for him, rather than just staying on the treadmill he is on and remaining frustrated.

The concept of taking a breath is something I often speak with CEOs about. Particularly in early stage companies, the founder/CEO tends to do everything, and as the business gets going they are rapidly consumed with the treadmill of day to day demands, and fall victim to the tyranny of the urgent. Moving from the massively hard task of launching a business to the herculean task of building a sustainable business requires a major change in CEO behavior. The first step is to take a breath and recognize the situation. The CEO needs a moment to reset and plot a path forward. Unfortunately, many entrepreneurs are so caught up in the moment and the crushing workload that they fail to consciously take a breath.

The same scenario happens in more mature businesses with experienced executive teams. Each executive is consumed with their own daily tyranny of the urgent, but collectively, the CEO and the executive team need to periodically take a breath. My approach is to schedule routine quarterly executive offsite meetings. Typically spread over at least two days so that there is evening social time to unwind together. Meetings have formal agendas and meaningful strategic topics to discuss and debate, but the key is to look a little further into the future to see what is coming instead of constantly being buffeted by unseen forces. The ability to look further into the future, or deeper into what is going on, creates the space to anticipate and course correct without falling victim to the tyranny of the present daily activities. A side benefit is it forces the executive team to disconnect from immediate issues, and rely upon their teams to hold down the fort. That means they have to have a competent team behind them, and at times the retreat will serve to highlight weaknesses in the next level team.

A wise manager I once worked for had an interesting saying — ‘always be decisive and make timely decisions,  but never make a decision until you have to, because you may learn more. The key is to know when you have to decide.’ It was his way to say ‘don’t procrastinate, but also don’t shoot from the hip without thinking about all of the angles.’ It was also his way of creating a pause to take a breath and make a well conceived good decision, not just any decision. In a fast paced, growth environment, everyone feels urgency, and they put that urgency on the shoulders of the CEO and leaders to make rapid decisions. The mantra to ‘take a breath’ is a way to slow time and make sure the urgency does not lead to carelessness or a treadmill situation.

The Staff Is Smarter Than You Think

CEOs and executive teams handle a lot of information, and some of it is pretty confidential or proprietary. There is always a question of how open to be with the staff versus how much to compartmentalize and keep secret. The level of openness is a style issue that starts at the top, and becomes deeply rooted in the culture of the company.

Small businesses are often quite transparent. However, as organizations grow, information becomes more compartmentalized and sharing drifts toward a ‘need to know’ model. As we move from a few colleagues that we know well and trust implicitly, to a staff of individuals who are in it for a paycheck, we tend to pull back on transparency. After all, you really do not know who is going to do what with your sensitive information. The dilemma is that the more you keep secrets, the less your team is likely to become engaged. By putting up barriers, you are actually driving team members to be disconnected, and you are fostering that 9 to 5 mentality.

Corporate info falls into a number of broad categories, and it can be helpful to think about how you want to treat information about each category in advance. Here are a few topics to consider:

• Financial information. Specifically, ongoing financial performance, cash flow, capitalization and ownership. Many companies share basic P&L data with the team as a form of scorecard. Cash flow is a little more sensitive as it may lead people to focus on the runway instead of the lift off. Capitalization and investment are often the subject of public press announcements — ‘we just raised $X million from YYY Partners,’ but individual investors and option grants tend to be much more sensitive.

• Human Resource information. This is a sensitive area fraught with personal data. The subtopics to consider are hiring and firing decisions. When and how do you want to share information about personnel changes, especially when it involves reductions in force? Every employee worries about their job, and any disturbance in the (work)force creates anxiety. This is the area where the CEO and exec team need to be at the top of their game. Past honesty in communicating HR decisions will build credibility and trust for when things get bad.

• Product information. New products and features are exciting and people like to talk about them. However, in a fast-paced competitive market, leaking foreknowledge of your product plans can provide your competitor with the opportunity to counter your attack. You need a clear strategy for managing internal and external information flow about product breakthroughs. The team needs to internalize what is at stake, and you need a trust environment with clear communication of authority and consequences for violating the confidentiality rules.

• Go to market information. The biggest topic here is typically sales pipeline information. Who gets to know about pending opportunities, and who gets to know about the forecast for the future? On the marketing side, metrics and lead flow may be informative about future performance, and as such may be confidential. How widely do you want to share this data?

• Customer information. Often, what a customer is doing and how they are deploying your product is considered confidential by the customer. Certainly, their data is their data and it needs to be respected. Beyond the confines of a single customer, consider how broadly you want to share customer lists, and customer health data. Pending or anticipated churn is often a sensitive topic that the exec team needs to have a plan for managing.

These are all examples of categories of information the CEO needs to consider when deciding how open an organization will be. In my experience, the greater the degree of transparency, the more engaged the staff will become, and the more trust you will build. It takes a village to be successful, and creating a shared trust and understanding of the facts of the business will help to create that village. Moving the needle from employment being ‘just a job’ toward ‘we are all in this together’ will go a long way to creating a resilient organization that can withstand the stresses of a growing competitive business. The staff is probably more mature and smarter than you think, and if you engage them they may surprise you.

One last note. Never underestimate the power of the corporate grapevine and rumor mill. Employees watch their leaders like hawks, and they perceive every nuance of behavior: is the door closed more often, are there more meetings, do the execs looked stressed, are voices louder or harsher than usual? Every element of executive behavior is a tell. Employees gather and disseminate information at the speed of light. On numerous occasions in my past, the executive team agonized about keeping a secret or how to share bad news, only to discover that everyone already knew it. The problem is that nature abhors a vacuum, so in the absence of a clear message from management, the grapevine will fill the void with its own interpretation of reality, and that is rarely positive. Bad news can quickly spin out of control while management is discussing and debating how to share the facts with the team. See my earlier post about the Ladder of Inference. Crisis management is an important part of the CEO’s role, and clear communication is a critical element of getting it right.

Everyone Needs A Friend

Being a CEO can be a lonely position sandwiched between the board of directors and the employees. Even though you are at the top of the corporate hierarchy and surrounded by your executive team and staff, it is an isolated role. You can build lasting and meaningful friendships with your team, but there is always a power dynamic where you, as the CEO, are the ultimate decider-in-chief, and you hold their careers in your hands. Business will always trump friendship, and the CEO is the one that may have to make the hard decisions about corporate direction, or whether or not to remove a teammate/friend from their position. To quote the great Stan Lee, creator of Spider Man, “With great power comes great responsibility.” This power dynamic creates a natural constraint on the flow of information.

A similar power dynamic exists between the board of directors and the CEO. The CEO and board must form a positive working relationship, but a fundamental role of the board is to hire and fire the CEO. Similar to the dynamic between the CEO and employees, the relationship between board members and the CEO has an underlying constraint on information flow that causes the CEO to be guarded about sharing uncertainty or showing vulnerability with board members.

Being sandwiched between employees and the board while carrying responsibility for all aspects of the business is what results in the CEO position being a lonely role. Regardless of experience level or business acumen, every CEO can benefit from a true business ‘friend.’ There are several ways to fill the role, but the requirements are pretty basic:

• The ‘friend’ has to be solely devoted to the success of the CEO. No ulterior motives or conflicts of interest.

• The friend has to be intellectually engaged in the CEO’s business and able to grasp the challenges the CEO is facing.

• The friend has to be able to subordinate their own ego and exclusively focus on the CEO’s needs.

• The friend has to be honest and able to hold up a mirror to the CEO, even if it is to show a painful truth.

In my past CEO positions, I have solved this need in different ways. One of my favorite approaches is to join a small, devoted peer group of fellow CEOs. I tried different types of groups, and found that the most helpful for me had the following specific characteristics:

• There was a facilitator who ran the group and imposed a structure on the meetings.

• Participants were required to prepare in advance and commit to be present for all meetings.

• Participants were all in similar, but non-competitive businesses. In my case, they had to be technology CEOs.

• Participants all had similar funding models. Mixing public company CEOs with private company CEOs does not work well. Blending self-funded CEOs with venture or PE backed CEOs also does not work well.

• Participants needed to be from similar sized companies at similar stages of maturity with similar growth objectives and similar experience levels. We had to be able to help each other, and feel like we all had something to contribute.

• Participants needed to have similar governance structures with a board of directors populated by institutional investors

I have tried CEO groups that did not follow these requirements, and it never went well. My craziest example was a group comprised of a sole-proprietor sod farmer, a friend-funded gravel pit owner, a PE backed healthcare company, and me - CEO of a VC backed software startup. Despite our best efforts, none of us could be very helpful to each other, and it turned into a waste of time. However, when I found a group that aligned with the requirements, it was life-changing.

An alternative to joining a CEO group is to find a CEO coach or mentor. A lot of people who make it to the CEO role have pretty big egos, and the idea of needing a coach may seem like admitting a flaw or deficiency. Our ego gets in the way of accepting help. The truth is even great sports champions all have coaches, so why not CEOs? A coach does not have to be able to do your job better than you, they only have to see how you can do your job better, and guide you to evolve to a better version of yourself. The most important rule for engaging a coach is that the CEO has to be the one who wants it, and they have to be the one to pick the coach. The coach can only serve the CEO. Too often, when the board thinks the CEO needs some help, they push for a coach, but problems arise if the coach is unclear about whether they work for the board or the CEO. It only works if the coach/CEO relationship is totally confidential, as if it is an attorney/client privileged relationship. No reporting to the board. The CEO has to be comfortable being vulnerable with the coach to acknowledge challenges and shortcomings without fear that the coach will rat them out to the board. In my experiences being a coach, it is vital for the CEO to understand that my sole objective is to help them become more successful.

Whether the answer is a coach or a peer group, the CEO has to take it seriously and commit the time and effort to do the work. Time is precious, and getting together with your coach or peer group has to be productive. It is not just a friendly shoulder to lean upon, although sometimes just venting an issue can be helpful. I am an advocate of making the sessions with a coach or a peer group structured. The CEO should prepare a brief and each meeting should review progress on past issues and address current challenges. Accountability is important, and that is where the coach or the peer group facilitator comes in.

In the situation where the board is uncertain about the CEO, they have a fairly blunt instrument to address the issue. Either they invest in the CEO to help them improve, or they fire the CEO and hope to find a better one. If the choice is not obvious, then the first step should be to help the CEO improve because replacing the CEO is a risky and painful decision. Investing in the CEO will either make the choice more apparent, or it will result in a better CEO. Coaches and peer groups cost money, and it is easy to question the expense or postpone the investment ‘until things are more stable.’ A common half-measure is to ask a board member to step in and ‘help’ the CEO, but that power dynamic thing will always get in the way. If the CEO is worthy of saving, then choosing to avoid the cost of an external independent coach or peer group misses the point. Investing to grow a better CEO is basically a self-funding investment that will deliver a high rate of return on investment.

The bottom line is every CEO can benefit from a trusted advisor or peer group, and every board ought to encourage the CEO to make the investment.

Board Conflicts of Interest

Each board member has an obligation to represent all of the shareholders and do what is in their best interest. In a simple cap table, where common is the only class of stock, everybody is in it together. All parties have the same interest, and share in the same outcome. What benefits one investor equally benefits all investors.

Unfortunately, this utopia has been dramatically distorted in most venture and growth-equity backed companies. The typical investment vehicle for institutional investors is preferred stock, or a similar instrument that puts the institutional investor at the front of the line when there is a liquidity event. They put their money in and want to be assured that they will be repaid before any common shareholders see a penny. In most cases, the preferred shareholders have the right to convert their preferred shares to common if the outcome is large enough that the common shares are more valuable than the preferred, so they win no matter what.

Preferred investors have gone even further with a few more aggressive forms of investing. One form is to structure their investment so that rather than having to choose either the preferred return or convert to common, their preferred shares get repaid (usually with interest), and then they also get a second bite at the apple by converting their shares into common and participate in the common shareholder payout as well. A second aggressive form of preferred investing is a preference multiple. With a preference multiple, the initial investment must be repaid two or three times before any funds go to common shareholders. In particularly egregious situations, investors may demand a preference multiple and participation rights, taking a second and third and possibly fourth bite at the apple.

The whole thing gets even more messy when there have been multiple rounds of institutional investments with different investor groups. The Series A preferreds may have different rights or economics than the Series B or C or D, and the waterfall of who gets what in a liquidity event can become wildly complicated. If the outcome of the sale is big enough, everyone gets a payday, but if the sale does not clear the entire preference stack, somebody is going to be disappointed, and the common shareholders are at the front of that line.

So what does this all have to do with conflicts of interest? Creating a collection of stock classes , particularly where the investors in each class include different institutions, introduces a governance challenge for the board. As noted at the top, each board member has an obligation to act in the best interest of all of the shareholders. However, the typical practice for an institutional investor is to require a seat on the board for a member of their investment firm, and that member’s first obligation is to their own firm. An exit that is acceptable to one investor may disadvantage another investor, just as the economics of the preference stack as a whole may disadvantage the common holders. So, who are the board members really representing, and whose best interest are they pursuing?

Let’s look at some examples that complicate this picture within the preferrence stack. Each investment fund generally has a limited timeline for holding an investment. An investor in Series A may make their initial investment expecting to exit after 3 - 5 years. However, if a new investor leads the Series C round two years later with an investment horizon of an additional 5 - 7 years, then the board members for these two groups are not aligned on their exit horizon. It is not unusual for exits to be driven by fund timing, and not by what is best for the business - aka common shareholders.

The same type of situation can occur when different series are led by different styles of investor. An early stage venture investor may have led Series A, while a later stage private equity investor may have led Series C. The venture investor is looking for high growth and is tolerant of losses or low earnings, while the PE investor is satisfied with more modest growth, but intolerant of losses or low profitability. The board and the CEO have to navigate these conflicting objectives and maximize the outcome for all of the shareholders, but it is challenging for the investors to take off their firm’s hat and put on their board hat.

When a company is doing well and everyone can see a fantastic exit approaching, most of these representation and governance issues fade into the background. Problems arise when the business is on a less attractive trajectory. It is really a problem if the company needs to raise more capital and some investors are open to the idea while others are eager to head for the exits. This is exacerbated when one of the funds is nearing the end of its lifecycle, and there is no additional capital available for them to invest. An investor who cannot participate with their pro rata share of a new round is often punished by the economics of the preference stack. As a result, they may press to sell the company rather than open the door to new investment. That might be good for them, but not necessarily good for the rest of the shareholders. The board member from that investor will face the dilemma of supporting what is good for the business and the other shareholders, or what is good for their fund. A pretty clear conflict of interest.

There are all sorts of justifications for creating multiple classes of stock. Institutional investors point to their capital as a high-risk investment that provides the lifeblood cash to fuel the business, so surely they deserve an outsized return. The problem is that this stuff gets out of control and the common shareholders, which includes the founders and the employees and the early seed investors, are the ones that suffer the most. We have all seen preference stacks with multiples and accumulated interest that far exceed the current enterprise value of a business. However, when the investors want out, the business will be sold. The preferreds may get two or three times their money, but the commons will get zero. This is the bargain that was struck when the money was invested, but it does not lessen the sting.

The economic model of the venture and PE industry is complex. These investors provide a vital engine to realize the creativity, innovation, and growth of breakthrough products and services, and they deserve returns commensurate with the risks they take. I do not have a perfect solution, but my observation is that the concept of multiple classes of preferred shares and the complex structures that have evolved to ensure outsized returns has created a monster. If we look at enterprise value more simply, then the price paid for shares should be able to reflect the risk and reward to support institutional investors needs. Rather than frame the investment as ‘I should get twice as much for my share as you get for yours,’ why not price it so that ‘I will pay half of what you paid, but we end up with the same class of shares?’ Alternatively, if the structure has to be ‘I get mine before you get any,’ then maybe the answer is a single preferred class and a single common class where preferred holders get paid before common holders. Within the preferred investor pool, we should be able to deal with varying returns through pricing, rather than the creation of new classes. There is probably no simple answer that will mimic the complex waterfalls we see today, but eliminating the conflicting agendas will enable board members to truly represent all of the shareholders without all of the inherent conflicts of interest the current system creates.

The Board And Operating Divide

The CEO and the board have a unique relationship. The CEO is typically a member of the board, but they also serve at the pleasure of the board. As a CEO, I was always conscious of the line between operations, which is the domain of the CEO, and strategy which is broadly speaking in the realm of the board. It is a unique relationship, almost like co-equal branches of government, but not exactly equal. Even though the CEO is typically on the board, they also work for the board, and the board has the power to hire and fire the CEO. My defenses used to go up when board members crossed the line into operations uninvited. My feeling was if they are unhappy with operations, their remedy is to replace the CEO, not do the CEO’s job for them.

An important step to create a great board is to recognize the different roles and establish a positive working relationship between the CEO, the board, and the executive team. I have observed board members who understand the co-equal nature of the CEO and board relationship, and form a collaborative working environment. There is mutual respect and an understanding that both parties are experienced professionals and have the same goals in mind. Unfortunately, I have also observed board members who project a superior, all-knowing attitude, and treat the CEO as an employee rather than a peer.

Sometimes, the nature of the relationship is determined by the investor’s model. In the venture and private equity world, some firms are control investors and require their portfolio companies to follow defined methodologies or playbooks. They set the operating procedures and are deeply involved in corporate operations. When a control investor acquires a business, it is important for the CEO to have their eyes open and understand that their degrees of freedom will be constrained. As long as the roles are clear, a healthy and productive relationship can be formed.

In contrast, when bad behavior sets in more organically, it can create a toxic environment, and the CEO will start to dread board meetings. This is usually the result of one or more board members adopting that superior attitude and creating antagonistic meetings.

Antagonistic board meetings lead to all sorts of bad behaviors. The meetings evolve into performative recitations of metrics (aka Dog and Pony shows). The CEO starts to focus on feel-good metrics that paint rosy pictures in order to curry board approval. They also tend to avoid bringing controversial topics to the board until they can no longer avoid them, which is usually too late to address them. There is typically a reluctance to bring members of the executive team to board meetings in an effort to shield them from bad board behavior. Worst of all, CEOs leave the meetings feeling beat up and demoralized, rather than encouraged and energized.

When a positive board and CEO relationship develops, there are many more opportunities for board members to become engaged and helpful. With a well curated board composition, each member is expected to contribute their skills to the mix. This is when the divide between the board role and the CEO’s operating role can blur in a positive manner. At the request of the CEO, I have often been asked to engage with members of executive teams to help them evolve into the leaders the CEO needs. When I was an operating CEO with a strong board, I did the same. The important point is to recognize that this type of involvement has to be at the request of the CEO, and the help offered must be consistent with the CEO’s operational direction.

One last ‘friendly’ reminder about the CEO / Board divide. The working relationship between board members and the CEO can be a beautiful thing. I often talk about a great board as a competitive weapon, and a strong bond between CEO and board is necessary in order for this to evolve.  However, as the CEO, remember that you are sitting in the middle between the people who work for you and the board of directors you serve and essentially work for. A CEO can be friendly with both, but a wise advisor once reminded me not to confuse friendship with business. Friendship only goes so far in a business relationship. In particular, the board’s duty is to the shareholders and not to their CEO friend. If operations are going poorly, the CEO owns the problems, and the board’s job is ultimately to hold the CEO accountable.

Great Boards Are Curated

I am a huge advocate of having an active and effective board of directors. For nearly any size company, and any form of capital structure, outside advisors can add value. In its simplest form, an entrepreneur may just need an independent mentor, or an advisory board that does not have corporate governance responsibilities. However, as a business starts to scale and become real, a true corporate board can be incredibly valuable. The CEO role can be pretty lonely at times, and a board can bring a unique perspective, and hold an honest mirror up to help you see the business with greater clarity.

You may have noticed that I keep caveating the message by saying a board ‘can’ be helpful. That is because not all boards are created equal, and not all boards are functional and helpful. I recently wrote about boards that are dominated by representatives of institutional investors. This is often the case in companies that have taken rounds of venture or growth capital from multiple institutions. Each investor group wants a seat or two on the board, and soon the board is comprised of a bunch of suits who are mostly focused on monitoring their investment, and only narrowly involved in real strategy, direction, and business challenges. Like the old TV show catch line ‘just the facts, ma’am,’ these board meetings turn into ‘just the metrics, ma’am’ exercises, and become a report card instead of a real business discussion.

A great board has to be curated. Each seat needs to be occupied by an individual who can add unique value and who also has the bandwidth to contribute. Investors who represent a firm with a diverse portfolio can bring a wealth of benefit to a CEO. They have perspective across multiple companies and industries, and see best practices throughout their portfolio. The key is they have to be present and own the responsibility that comes with holding a seat. One of the questions I often ask is ‘how many boards are you on?’ There is no magic right answer, but too many is bad, and unfortunately investors often take on too much. It becomes hard to keep track and stay engaged with each company when trying to serve too many businesses. The distractions lead to what I call ‘board amnesia.’ From one meeting to the next, over-committed board members forget the nuances of decisions they helped make, and it often feels like they are starting over at each board meeting. As a CEO, this is incredibly frustrating because you have to constantly re-litigate topics over and over.

As companies move toward a liquidity event or sale, the die is basically cast, and the focus turns almost exclusively to short term execution, and away from making long term strategic plans. At this point on the journey, a well curated board should have one or more members who are experts at exits, and can help the CEO navigate the sale process to maximize the value of the company. For some board members, I have seen this become their queue to step back and put their attention elsewhere. The implicit message is “this one is done, and my time is better spent on the next one.” While there is some validity to this thinking for an investor with a portfolio to service, it can be very disheartening for the CEO and team. They are still charging hard and fully accountable, and they want their board members to stick with them to the end. Not all exit processes run smoothly, and some fail to result in a transaction at all, so the CEO and the board need to continue to collaborate for the present, and remain engaged as if there is a future, right up until a deal is done.

The CEO needs to be able to have a frank conversation with individual board members to hold them accountable if/when their contribution is fagging. Board members should recognize their obligation to be engaged and present, and if a board member cannot devote the time, then they should be willing to give up the seat to someone who can.

At all stages, a great board is a competitive weapon. Each participant has a purpose and is engaged to contribute time, energy, and expertise to build and nurture a successful company. I am biased, but I believe one of the most important board roles is that of the independent(s). Independents may be industry experts, or experienced operators. Their purpose is to add perspective and to be a solid bridge between the CEO and other board members. As a contributor to building the board as a competitive weapon, a former operator can bring unique insights and best practices with hands-on experience. If functional areas of the business, or members of the executive team need a little help and mentoring to grow, the CEO should curate the board to include an expert who can bolster those functional areas. It could mean adding a CFO to the board to help the operating CFO advance, or a CMO or CRO to help with go-to-market strategies, or a technologist to help guide the CTO. In my biased opinion, a former CEO is an ideal addition to a board. For less experienced CEOs, adding someone who has been there and done that can help them grow in their job, but regardless of the experience level of the operating CEO, a former CEO has walked in their shoes, understands the challenges and can relate to the issues. They can be a coach and a sounding board for the CEO, and they can add perspective and help other board members see the business through the lens of a CEO.

Whatever the unique needs and challenges are for the growth and success of the business, the CEO should insist on constructing a board that can help. Astute investors acknowledge that it is important to have the right people on the board, and the best person may not be a member of their investment team. If everybody focuses on the concept of building the board to be a competitive weapon, then making the right choices to fill the seats will become obvious.

Align With Your Buyer’s Journey

I had several interesting discussions recently about vendor sales and marketing roles throughout the buyer’s journey from interest (top of funnel) to purchase (bottom of funnel), and how a SaaS marketing and sales team aligns with the buyer’s needs. It made me think more about full-funnel management and the need to reflect the buyer’s journey in the way a sales team supports the process. Buyers used to follow a path from discovering marketing materials and doing casual shopping, to raising their hand, to asking for more information, which led to a sales development rep (SDR) or a sales person getting involved. This was a key handoff point between marketing and sales. Marketing content remained relatively high-level, and the handoff to sales took place in the upper part of the sales funnel.

What changed in the last several years is that enterprise shoppers do much more research on their own before they are willing to engage a vendor’s sales team. Outbound marketing techniques no longer entice shoppers to raise their hand before they are really educated and ready to make a purchase decision. The result is that the handoff from marketing to sales has moved further down the funnel, and marketing has had to adapt by expanding its role beyond surface creation of awareness to serious nurturing and education. It has also shifted the initial sales role further down the funnel, and changed, or eliminated, the SDR function. This all means a change in the staffing criteria for sales and marketing, and in some markets, it has expanded the role of channel partners. 

Let’s look at these changes one at a time. As you move down the funnel and the buyer is seeking more and more education and doing extensive research, the content put forth has to become more and more specific and deliver much greater depth. In many cases, a marketer who was comfortable at the top of the funnel with value messages and positioning statements is not sufficiently technical and comfortable creating the materials that will carry the buyer down through the funnel to the point where they are ready to speak with sales. Marketing leaders need to adapt their hiring practices. Their team needs more domain expertise in content creation, and more target market awareness in demand generation. Marketing’s role has to shift from generating basic brand awareness to building market credibility. Marcus Sheridan wrote a terrific book titled “They Ask You Answer” about becoming the shopper’s ultimate source of market information as the key to building credibility.

As the contribution from marketing becomes deeper and moves further down the funnel, the leads handed to sales are more knowledgeable, and further along in their journey. The result is that the SDR role has to adapt or disappear. Too often, the SDR function is an entry-level gate keeper with a primary purpose of screening out unqualified leads to avoid passing along shoppers who will waste a salesperson’s time. From the perspective of the vendor and the sales person, this may be efficient, but from the perspective of a knowledgeable buyer this can be very inefficient and annoying. At a minimum, as buyers become more sophisticated, and the first contact with sales moves further down the funnel, the SDR role requires much more product and market awareness.

Alternatively, we just need to eliminate the SDR role and focus on the seller filling the need. The change in buyer behavior means that by the time a seller gets involved, the nature of the questions and the specificity of the buyer’s needs are well formed. Buyers expect the seller to be an expert and provide specific demos and information about exactly how the solution will meet their unique needs. For some vendors, this means sellers have to also take on more of the traditional sales engineer responsibilities, or perhaps staffing ratios of sellers to sales engineers will need to change. The overriding message is that as buyers become more sophisticated, vendors need to adjust their selling methods to meet the buyers where they are today, not where they used to be. Many of the CEOs and sales leaders I have spoken with argue for expanding the role of a seller to be a full-stack player. More qualified sellers with fewer supporting contributors such as SDRs and SEs.

This change in buyer sophistication also opens the door for a different voice to participate in the process. In many markets, a channel partner or MSP may be the perfect match. Channel partners are force multipliers, but they also may have much deeper market awareness and a better understanding of the specific needs of the shopper. The partner can become the trusted expert advisor, and they can be the sherpa that carries the shopper to become a buyer. This is not a new or radical idea, but putting the shift in buyer behavior in the context of full-funnel management and factoring in the delineation of duties between the vendor’s personnel and channel partners can lead to a redesign of the marketing process and the sales cycle that will benefit both the vendor and the buyer. Vendors need to consciously strive to meet the buyer with the smartest person in the room who will be able to guide the shopper through the funnel.

Mommy Daddy Syndrome

Anyone with children has had the experience of saying ‘no’ when asked for something only to later discover that your child went to their other parent and managed to coerce a ‘yes.’ Kids learn which parent is most likely to say yes or no to each type of request, and they shop for their desired result. A similar thing happens in corporate interactions. Team members are really adept at learning who to ask for what, or who will be more open minded about a topic, versus who will shut down discussion.

Similarly, A CEO needs to build sufficient rapport with each board member to understand how they think and who to ‘shop’ for what opinion. When seeking advice and a ‘yes,’ the CEO will want to start with the board member most likely to be supportive and helpful. They can help the CEO explore all of the angles and test the idea before presenting it to the entire board. Once the idea is well formed, and you basically have your ‘yes’, the CEO should engage that member to help lead the board discussion. Its like getting Dad to explain to Mom why he said ‘yes’ when she said ‘no.’ In essence, you want to bring the key board member to the CEO’s side of the table, and engage them to assist with guiding the full board to ‘yes.’ Involving a key board member will also help the meeting to be more collaborative and less performative for the CEO.

A well formed board will not be homogeneous, and each board member will have unique experiences and strengths that add to the effectiveness of the board and the value to the CEO and executive team. The goal is to make the board a competitive weapon that assists the CEO to build a successful company. As such, each board seat should be filled with an individual who adds to the competitiveness of the weapon. Too often, particularly for businesses that have been through several rounds of funding, the board is comprised almost entirely of institutional investors. Institutions often demand a board seat as a condition of their investment, so after a couple of rounds there are a lot of suits on the board. The key is for these experienced investors to ensure that their participation adds to the competitive weapon — they have to do more than monitor their investment, and they have to work hard to contribute to the business. Sometimes, instead of adding another financial person to the board, the smart choice is to insist that the board seat is filled by an industry person or an operator who can help the executive team mature.

When the entire board thinks of itself as a competitive weapon, you open the door to jointly develop battle plans, and assign roles and missions to leverage each board member’s domain expertise. As the CEO discovers the unique strength of each member, they can hold them accountable to contribute their strength, and engage them as needed when shopping for that ‘yes.’ One member may be an M&A deal-finder or deal-maker, while another may be able to add technical expertise, or marketing skills. A member who comes from the company’s industry may have connections with potential customers or possible business partners. If a board member only sees their role as protecting their fund’s money, they are probably not adding enough value. Board members should constantly if they are doing enough, and what else they can do to be helpful. They should also be holding each other accountable to actively participate.

A great board is a thing of beauty, and as a CEO, it is a gift. However, that gift requires hard work, and bringing it to fruition largely sits with the CEO to make the effort to leverage each board member’s unique strength.

Manage The Signal To Noise

In a prior post, I focused on building a collaborative relationship between the board, the CEO, and the executive team. The watchword was ‘no secrets and no surprises.’ The challenge is how to effectively communicate and contextualize the metrics and measures being reported?

The most important line in corporate communication and analysis is the time line. For every metric, there is always value in knowing what happened in the past, what is happening now, and what we expect to happen in the future. One data point does not define a line, so reporting key metrics as single data points is pretty meaningless. We always want to understand the ‘now’ data point in the context of what happened in the ‘past’ that led up to ‘now,’ and what to expect for the ‘future.’ A single data point begs the question ‘so what?’ that I have written about often. If we cannot contextualize a metric with its past trend and future expectation, then we at least have to answer the ‘so what?’ question. Why is this lonely, solitary number important, and what does it mean to the business.

In formal and informal communications with the board, the CEO has to be a discerning editor and monitor the channel to manage the signal to noise ratio. Signal represents the well formed information that carries context and meaning, while noise is the superfluous data that does not answer the ‘so what?’ question, or is merely  a stream of feel-good or happy metrics that do not reflect meaningful measures of business accomplishment or health. The CEOs role is to amplify the signal and tamp down the noise. Here are a few tactics:

• Do not become trapped by an obligation to report some data value just because you reported it in the past. I have seen board books balloon in size over time because at some point in the past, someone asked a question, and forevermore we include the answer in the book — even if it is no longer relevant or meaningful. Current events and performance will dictate what is meaningful and informative about the business. Board members will want to drill down on ‘hot spots,’ but once the moment has passed, yesterday’s hot spot may no longer deserve the spotlight it commanded in the past. What was once signal will fade into the background and become noise. Manage it accordingly.

• It is valuable to engage executive team members to create their own contribution to the collective board reporting. However, there is often a tendency to preen and showboat, and present too much happy data (noise) that drowns out the meaningful information (signal), or to avoid the troubled areas and only report the positive outcomes. If you think in terms of board slides, then limit each contributor to one slide, and require the font size to be no smaller than 16. If a contributor thinks they needs more space, make them justify it, and do not give in easily.

• Require contributors to think in SWOT terms (strengths, weaknesses, opportunities, and threats). They do not necessarily have to present a SWOT analysis, but they have to at least consider whether their page is presenting a balanced view. The CEO-editor has to keep them honest. Do not become complicit in their ‘happy ears’ version of what is going on in their area.

• Often, different executives will report measures or metrics that sound similar, but reflect different values. The CRO may categorize sales leads slightly differently than the CMO, or bookings different from the CFO or the CCO. The CEO-editor needs to look across all of the slides and ensure consistency. Board members are really good at finding a number on slide 7 that is different than a number on slide 27, but labeled the same. At best it requires explanation, at worst it erodes confidence. Take the time to catch the inconsistencies. I suggest tasking the CFO to be the score keeper to check every number across every slide.

• Add the dimension of directional indicators to your reporting. Typical Red, Yellow, Green stoplight charts are one dimensional. They report on how things appear at a point in time. The real question is where is the metric going. Is it green today, but we can see it turning yellow or red in the future? Is it red, but rapidly improving? Is it stuck on yellow like a low-grade fever, so it is an irritant that requires attention, even though yellow may not be that bad? An easy method to augment a stoplight chart is to add a directional arrow (up, down, neutral) to each color. The context of direction and trend will dramatically amplify the signal.

• Engage an independent board member or the `chairman to preview and proof the board pack before it goes out. The CEO knows so much about what is going on that they may subconsciously fill in the blanks with knowledge that makes the slides make sense. A friendly board member will read the same slides and find the gaps in logic or explanation or missing bits that seemed obvious to the CEO. They will read it like their fellow board members will, and their input will make the presentation better.

• Lastly, ask for feedback. After presenting board materials, ask the recipients how effective the presentation was. Press them to candidly critique the information packet. Ask what can be eliminated, and what should be added or amplified. Ask a similar question to a CES survey (customer effort score). ‘How much effort did it take to understand and get value from the materials?’ CES is typically measured on a scale from "very low effort" to "very high effort." Most commonly, on a scale from 1 to 7. It is a great ice-breaker to ask this of board members because it does not require them to be specific about any particular element of the pack, it just elicits a general satisfaction response that can trigger deeper conversation.

Effective communication is a skill that is particularly critical for the CEO when engaging the board. Filter out the noise and amplify the signal. It will remove distractions and help everyone focus on what is important.

An Effective Board

Not all boards of directors are created equal, and not all CEOs and management teams have figured out how to have an effective working relationship with their board. I have observed more than a few CEOs who view their board as a necessary burden, but not a helpful business partner. In some cases, the relationship is ‘chilly’ at best and ‘hostile’ in the extreme. In early-stage businesses, where the board may be dominated by representatives from the financial institutions backing the business, meetings can drift toward the CEO putting on a ‘show’ to deliver metrics and financial results with very little consideration of strategy and direction. In my own experience, I once asked board members to participate in a discussion of potential future markets, and one investor-member declined and actually said he was only focused on the numbers, and did not know anything about the market. It is critical for a board to be engaged with management at a level that they clearly understand the market and strategy of the company, and can actually add value. 

Teams go through stages of development from Forming to Storming to Norming. It is a process of finding normal and becoming productive. In striving to operate as a team, CEOs and Boards follow a similar development. In a new CEO/Board relationship, Forming is a time of getting to know each other, characterized by polite, generally non-controversial conversations. This is the time when everyone is getting up to speed and on the same page about the business. To accelerate the process, it generally requires much more involvement than simply a few hours every quarter. The CEO needs to engage with board members beyond board meetings, and board members need to do their homework. Nobody is closer to the business than the CEO and the executive team, so the CEO should feel responsible to provide board members with sufficient background to enable them to be effective participants in the business.

Once everyone is up to speed on the fundamentals of the business and the market, the CEO/Board team will move on to the Storming phase. Smart people will form their own opinions and challenge the opinions of others. This is when the board and CEO are able to have real conversations where they compare and debate strategies and direction. Meetings become meaningful and helpful to the business, and no longer performative reporting exercises. As the board coalesces on strategy and direction, the relationship moves into Norming. Finding normal sets the foundation for ongoing relationships among board members and with the CEO and executive team. This is when boards become truly productive and CEOs welcome their participation.

In a healthy board environment, the CEO and the functional leaders of the company should feel comfortable and free to reach out and engage board members in between board meetings. They should welcome the advice and counsel of board members. It doesn’t have to be all sunshine and positive results. In fact, these periodic check-ins should communicate brewing issues or concerns so that the board is aware of them long before they reach crisis levels. It is an opportunity to solicit the advice and assistance of board members to head off future disasters.

The most effective boards have ongoing and continuous conversations with the CEO. No secrets and no surprises. Similarly, the most effective board members will have open and frequent conversations with each other. The more the board members converse and get on the same page, the better they are able to speak with a unified, non-confusing voice when interacting with management. I am an advocate of establishing a digital channel such as Slack or MS Teams for ongoing board discussions. Most board members are busy people, and scheduling conversations is a burden. Asynchronous messaging is an effective way to move discussions along without requiring members to schedule calls or meetings. When the entire team is aligned, everything moves forward more smoothly. The key is to recognize that the CEO and the board of directors are on the same team. In order to become effective the full team needs to develop a collaborative approach to driving business success. Turn the board into a competitive weapon and not a business burden.

This Is Not Normal

The first quarter of the new year is typically an uplifting time for companies. Most businesses create annual operating plans, and the first quarter is when they launch them with enthusiasm and optimism. We typically know more about where we stand going into the first quarter than we know about how things will look twelve months later, so the goals seem more believable and attainable in Q1. Sales teams have their annual kick-off meetings with lots of fanfare, and marketing teams launch new and exciting campaigns in Q1. Based on Q4 sales successes, implementation and customer success teams enthusiastically engage new customers with renewed optimism for retention and expansion. First quarter rocks - normally.

However, with all of the recent economic and market turmoil, I am having a Covid-like moment as we enter Q2. I vividly recall when the Covid pandemic hit us just as we were wrapping up Q1 2020. Commerce came to a halt and every business went into survival mode. Unfortunately, it feels eerily similar right now. Back then, uncertainty about supply chains caused panic buying on one hand, and paralysis on the other. Today, nobody knows how permanent the tariffs will be, or exactly how the economy will evolve. There is reluctance to make big financial decisions, and that introduces uncertainty into every business.

For recurring revenue companies and SaaS technology vendors, this is a time to focus on retention of existing business. To do so, it is critical to understand your value to your customers. Is your offering a “vitamin or a cure?” Are you a “nice to have or a gotta have?” Do you really know why your customers do business with you and what value they attribute to your offering? Have you asked? You might be surprised to actually learn where your customers derive the most value, and that knowledge will be the key to ensuring you maintain the business you already have. Absolutely understanding your unique value proposition, based on real client feedback, will also be fundamental for you to convince nervous prospects that they should proceed to buy, despite the economy being in turmoil. The imperative in these crazy times is to recognize that it is not business as usual.

Step one is do not panic. However, take the time to formally assess how current events may impact your business. Determine your vulnerabilities and opportunities, and consider creating a revised plan that addresses the potential impacts. Establish the trip-wires that will cause you to activate your revised plan. This is not a time for ‘happy ears’ or blind optimism, rather it is a time for honest appraisal and realism. Consider the implications of rising costs of goods and operating costs. Evaluate your pricing model and the implications of increasing your price to offset increasing costs. If you anticipate the need to remove cost from your business, when do you expect to pull the trigger, where will you look for savings, and how will it impact your business moving forward? The objective is to put enough time into contingency planning to create a foundation on which to act if the world continues to spiral, and to identify the indicators you will watch in order to determine if / when it is time to act.

As a CEO, this is an ideal moment to engage your board of directors. Members of your board are likely to be involved in other companies, and you will benefit from the portfolio effect of their ability to look across different markets to understand the business landscape. Board members should insist on having this discussion with their CEOs. These are not normal times, and economists are all over the map in their predictions of boom or recession. The only prudent thing to do is to have a measured discussion of the implications and to formulate a shared perspective and plan for how the business should navigate the choppy waters ahead.

Practice Productive Paranoia

We like to look on the bright side, and focus on successes and positive elements in what we do. It is great to approach work with a positive attitude, and that outlook will rub off on everyone around you. However, we also have to be wary of what may be around the corner or lurking in the shadows that is going to get us. I used to work with a sales leader who constantly challenged his team to identify the “should have, could have, would have” elements of any deal they were working on. In other words, what could go wrong that you “should’ve, could’ve, would’ve” avoided if you had just looked for it? Another sales leader referred to this as Productive Paranoia, and I love the term. 

Productive paranoia means a range of things. Late in a sales cycle, if the buyer suddenly says they need to arrange “just a quick demo” for our execs before they sign. It could be a good thing that shows we are one step closer to winning, but productive paranoia also tells us something could be wrong. Most likely, some exec is objecting to the purchase or the price or wants to add to the requirements before they buy, or is pushing an alternative and wants to demonstrate that we are not the right choice - something has gone off the rails. When a customer is going through an implementation and they suddenly slow down or ask to pause, we could see this as normal, or even think this is great because it gives us more time to get other things done. But, productive paranoia alerts us that  something is probably wrong and we need to figure it out fast. One last example, if we don’t hear from a customer for a stretch of time, it could mean everything is going fine and they are happy, but productive paranoia tells us we ought to initiate a conversation and assume something is amiss. Worst case in all of these scenarios, you over-prepare for a positive outcome. Best case, you saved the day by being paranoid.

Andy Grove, the founder of Intel, wrote a book titled “Only the Paranoid Survive”. His whole message was to always be on your guard. Always look several steps down the road and plan for the worst. A quote attributed to Joseph Heller is equally true “Just because you're paranoid doesn't mean they aren't after you”. In a competitive environment, you can always assume your competitors are trying to torpedo your sale, or steal your customers. Even in a friendly customer relationship, it is prudent to assume there is at least one user or executive that is not happy with your solution and is out to get you.

In a sales setting, the best defense is a well thought out sales cycle that defines the Actions, Artifacts, and Timing of every step of the journey. Actions, refers to who is doing what at each stage of the cycle—on both the vendor’s side and the prospect’s side. Artifacts, refers to measurable outcomes from the Actions. They demonstrate that the actions occurred. Examples may be proof that a demo happened and the right attendees were present, or a plan was delivered and the prospect responded positively and agreed to a project plan. These are the items a sales manager wants to see to be assured that the seller is doing the right things in the right order.

The third element of a solid sales plan is Timing. This is where productive paranoia comes into play. Sharks suffocate if they stop moving, and the same is true for enterprise sales opportunities. If a qualified buyer has engaged in a sales cycle, then you should assume that like the shark, the deal should be constantly moving forward or it is dying. The sales cycle plan should have an anticipated range of duration assigned to each step. For example, if the next step in your plan is a demo, then the plan should say how soon it should occur. If a demo is typically scheduled within 1–2 weeks of the prior step, and it has been a month since the last contact, something is wrong. Every step of the process should have a planned duration, and if a deal stalls on some step of the process for longer than the allotted duration, productive paranoia should kick in immediately. Think about it like the shark, and assume that a stalled deal is a dying deal. Something went wrong and you need to resuscitate the opportunity.

In an ongoing customer relationship, the triggers for productive paranoia may be more subtle. Once again, however, the best defense is to construct a plan for a healthy customer relationship and track Actions, Artifacts, and Timing. Most enterprise platforms capture usage data, and this is a great source of metrics for Actions and Artifacts. As in the sales cycle example, the customer success team needs to marry the usage artifacts with anticipated timings. How long is it taking to launch the platform, how fast are users coming up to speed, was there a delay in the rollout, etc. I am an advocate of planned and scheduled routine customer meetings. Productive paranoia should kick in when a previously scheduled meeting is delayed or cancelled, or when key participants stop attending.

Assume that there is always someone lurking in the shadows trying to steal the business away. Do I sound paranoid? I am a firm believer that we have to celebrate success and look at life through a positive lens, but that doesn’t stop me from always doing the “should’ve, could’ve, would’ve” conversation. By the way, Joseph Heller probably did not write that line, and it does not appear in the book “Catch 22” as is generally assumed. It does however appear in the movie version of Catch 22, and some people think the screen writer Buck Henry came up with the line.

Map The Journey

When a customer decides to license your enterprise platform, it is valuable to consider the long view of the journey that lies ahead. Vendors often focus on “implementation” as if it is a monolithic single step. In reality, implementation has several discreet components, and beyond what is typically seen as implementation, the buyers journey has many more phases. Vendors that are savvy about managing their customer base for extended lifetime value (LTV) and ongoing license renewals are typically looking out beyond the initial implementation and plotting the entire journey. These vendors understand that success will require them to become the customer’s long-term partner in order to ensure customer retention. The team that made the buying decision may stay with the project, but there will likely be new participants, and as the journey passes through inevitable milestones, the jobs and the participants will evolve. Savvy vendors anticipate the changes and design their Customer Success offerings accordingly. 

Licensing is just the start of the journey. The first job is to configure the new platform and turn it on. This is the implementation step that sets the stage for the jobs to follow. The vendor’s services team will work with the customer implementation team to define the flow, look, and design. Next, the jobs shift to filling the system with content.  Encouraging buyers to discreetly think about this step of creating and loading content from the beginning will help them to recognize that it is distinct from making the platform work. Early on, it is imperative that the customer’s team become trained and proficient with the platform so that they are prepared for the next phase of the journey. Launching the new environment to their internal peers and the broader team within the customer is a discrete job. The vendor needs to ensure that the customer’s team has become experts, and that they have a viable plan to train their peers to gain internal engagement. Success requires engagement and spread within the customer’s teams, so the platform vendor must have a plan to facilitate this phase of the journey.

If the ultimate users of the new platform are external to the customer, then the next phase is to roll out the platform and drive uptake in the field. An engaged vendor will recognize that success lies in the adoption of the platform by the ultimate users, either internal or external to the buyer. The vendor needs a clear understanding of the value their platform is providing, and the customer success team needs to see it as their job to drive toward that value.

Expanding on the concept of taking the long view, vendors have to guide customers to understand that nothing is static. All enterprise platforms require continuous improvement and enhancement, and that requires ongoing investment. If we think about implementation as winding up a clock, then we can envision that during the customer journey the clock slowly winds down. The system will become stale and satisfaction, if not engagement, will start to drop off. The ‘clock’ will need to be ‘wound up' again and again in order to remain relevant for the long run. The Customer Success team will need to drive customers to allocate resources and budget to refresh the platform, and this is best accomplished if you enter the initial engagement with an explicit long-term plan.

If we are clear from the start that a prospect is embarking on a long journey, and we articulate the major phases of achieving success, then we open the door to position our range of value-added services to augment their team and guide them through the journey.  We can clearly differentiate implementation from creating and loading content.  We can create a space for training the customer’s team, and position it as a prerequisite to launching internally and if appropriate externally. And, we can open the customer’s eyes to the need to receive feedback and keep the site fresh with dynamic ongoing investment.

Too frequently, vendors mix it all together in a single soup called implementation, and prospects always try to negotiate to minimize the cost of implementation when they are buying. If a vendor presents it as a mechanical step to turn the system on, then the buyer is insufficiently aware of the challenge that lies ahead to actually achieve value.  As they progress through the project, the scope of the journey will start to become clear and they will see the project demands and investment expand. At some point, the customer will become unhappy because it is taking too long and requiring more effort than they anticipated. Helping the customer to appreciate the journey and the unique jobs along the way will create a positive path to success. A vendor that demonstrates expertise and best practices in a way that shows they know what it takes for a buyer to be successful will build confidence during the sales cycle, and if the vendor holds its head up high and acts like the experts that they are, customers will recognize the value of their guidance and realize that this is the vendor that can help make them become heroes.

Customer Retention Matters

I recently wrote about the seeds of churn being sown in the first few weeks following the sale. A wise friend and colleague pointed out that often the seeds are actually planted during the later stages of the sales cycle. Buying decisions take on a life of their own, and buyers get wrapped up in their commitment to get “something” done. Sometimes, they fall out of love with their choice before the deal is ever closed, but the deal momentum carries them through to signing. When this happens, they are disengaged before they ever become fully engaged, so the post-sale tasks become even harder.

SaaS businesses focus a ton of attention on new-logo sales. They closely monitor key SaaS metrics such as ‘Customer Acquisition Cost’ (CAC), and the CAC Ratio which measures the relationship between bookings and the sales and marketing expense required to achieve the new revenue. However, once the deal is signed, they metaphorically throw the new client over the fence to the post-sale team. From that point forward, our next important measures are ‘gross retention’ and ‘net retention,’ which do not become visible until long after the deal is signed.

It got me thinking about how vendors allocate their investments to maximize retention and avoid churn. How do companies know if they are adequately investing in their post-sales functions to ensure client satisfaction and avoid churn? According to SaaS Capital’s “2024 Spending Benchmarks for Private B2B SaaS Companies” https://www.saas-capital.com/blog-posts/spending-benchmarks-for-private-b2b-saas-companies/ the median percent of annual recurring revenue spent on customer support and customer success was 8.5%, down from 10% the previous year. The same study found that companies spend about three times as much on Sales and Marketing for customer acquisition.

Every year, SaaS vendors aim to renew and expand their recurring revenue (ARR). Hopefully, there are multi-year contracts in place that auto-renew, but invariably a large percentage of the ARR needs to be re-signed each year. If a SaaS business has been around for a few years, and if they have been relatively successful at retaining customers, then the retention ARR is far bigger than the new-logo ARR. After all, the base is the sum of all of the years of new-logo selling. And yet, on average we are spending one third or less on retention than we are on new sales and marketing.

Simple math tells us that investing to retain a customer is a solid investment. Consider a $100,000 annual revenue account, with a retention expectation of four years. That account is worth $400,000 to the vendor, not to mention upsell potential. At 8.5% average investment, we will spend $8,500 per year to keep the account. Depending on the business, that may be an adequate amount, but if churn is a problem, then we have to view our post-sale investment with a different perspective. It will cost us $50,000 or more to replace the same revenue, so maybe spending a bit more to make the customer happy is a better investment. Understandably, winning a new logo is typically harder than keeping a satisfied customer, but still it seems a bit odd that the investment in retaining the vast majority of the revenue is so much lower than what is spent on new logos.

I suggest that in addition to tracking the gross and net churn numbers, SaaS businesses should also benchmark their investment in retention. My suggestion is a Customer Retention Cost Ratio (CRC). Just as the CAC Ratio measures the relationship between bookings and the sales/marketing expense for new revenue, the CRC Ratio should measure the relationship between renewal  revenue and the investment in customer support and customer success. For good measure, we could include any investment in customer marketing, and maybe even the engineering investment in bug fixing. The goal of measuring the level of investment in retention is to complement gross and net retention measures. If retention is dropping, the CRC Ratio will give us a perspective on what we are investing to keep the revenue, and provide a benchmark for comparison to other companies.

From an investor’s perspective, companies with strong customer retention and low CRC should be highly valued, while companies with high CRC and low retention are exhibiting a low value problematic profile. ‘Growth rate is positively and exponentially correlated with net revenue retention. Increasing Net Revenue Retention (NRR) from the 90% to 100% range to the 100% to 110% range improves growth rate by 10 percentage points. Companies with the highest NRR report median growth that is more than double the population median. This is a rare example of increasing returns from investment in upsells and cross-sells.’ (https://www.saas-capital.com/blog-posts/growth-benchmarks-for-private-saas-companies/)  It is also estimated that ‘for every 1% increase in revenue retention, a SaaS company’s value increases by 12% after five years’ (https://churnzero.com/churnopedia/net-revenue-retention/) Investing in retention is one of the most capital efficient paths to growth and maximizing value.

The bottom line is that retention is a powerful growth lever, and companies need to be thoughtful about the relationship between what they are investing to retain customers, and their actual rate of retention. Small increases in retention can manifest significant increases in corporate valuation. The Customer Retention Cost Ratio is a tool to understand the relative investment in retention and the impact it is having on revenue.