Is It Time To Go?

A recent article published by Heidrick & Struggles titled ‘Board Monitor US 2026,’ presented an interesting view of the contribution of board members in a survey of Fortune 500 companies. Among the many incites in the report, one that stood out was how the tenure of board members relates to their effectiveness. In the public sector, the average tenure is approximately seven years, and the companies add new members only every two-and-a-half years. The paper points out that many board members were appointed before the Covid pandemic, and certainly before the rise of AI. The businesses have undergone radical changes as a result of these events, so the question is how has the board evolved and is it still effective?

I have long written about the concept of curating the board of directors to be a competitive weapon. This can take many forms based on the specific needs of the business. In some cases, it means aligning board member expertise with areas of operations that need help such as finance, or go-to-market, or technology, or services. In other cases, it may relate to adding board members with specific industry sector knowledge or contacts. The important concept is that curating the board is an ongoing process. As the business grows and matures, its needs change. Perhaps the original CFO was relatively inexperienced, so we added a strong finance participant to the board. In time, when the company replaces the original CFO with an experienced veteran, the need for that strength on the board may diminish. It may be time to bolster the company in a different way with a different board member. This scenario will play out for every curated area of the board as the company evolves.

Boards are quick to point out weak players on the executive team and coach the CEO to replace them, but rarely do boards demonstrate similar introspection regarding board participants. In the institutionally backed private sector, institutional funds typically demand one or more board seats as a requirement for making their investment. If a company has grown through several rounds of investment with an expanding list of institutional investors, it is not uncommon for the board to be dominated by ‘suits’ representing the investors. Often, these are highly talented individuals with lots of portfolio experience and strong pattern recognition, but they also often lack relevant operational experience and specific market insights. Early stage investors may have early stage experiences that are not be as effective as the company grows, but by contract they stay on the board. The early-stage investors may still be playing ‘small ball.,” which can become a problem as the company strives to make bigger and bolder decisions that require bigger thinkers. The The board needs to grow up as the company grows up.

This is where the role of the independent non-executive director (NED) comes into play. Investor board seats are contractually controlled by the investor funds, so there is little the CEO can do to curate these seats, although it is always worth a try. However, the NED seat(s) are where real curation can occur. The focus for the CEO should be to fill NED seats with individuals that can best help the company. Recognizing that the company’s needs will evolve over time, a best practice is to set a term for the NED up front — often two years. It does not mean you have to replace the NED at the two year mark, but it will force a conversation and if the decision is to part ways, it removes the drama from asking the director to go.

Looking back to the findings in the Heidrick survey, in the public space the average board tenure is seven years. In the private sector, institutional investors typically hold their positions for a similar five to seven years, so it is quite possible that the investor board members will have a similar long tenure with the company. In the public sector, Heidrick found that new board members are added approximately every two-and-a-half years, which aligns with my suggestion to set two year terms for NEDs. In other words, the Heidrick findings are aligned with the private sector, so we have to ask if that makes sense given that smaller private companies grow and change much more rapidly than large publics?

In my experience, private company boards become stale over time, and their contribution as a competitive weapon diminishes if it is not refreshed. This is particularly true when the business is a steady average performer. Steady can be boring, and bored board members can fall into pattern behaviors that fail to recognize threats and opportunities. At the other end of the spectrum, many private companies grow and morph much faster than publics. They are much more sensitive to market changes and competitive winds, and they require much more from their board in terms of operational guidance and the ability to see around corners strategically to plot a course forward. Both of these extremes and everything in between demands an active process to curate the board. It is incumbent on the CEO and the board to avoid board complacency. Remember, a board member that joined the company seven years ago, joined before Covid and before AI. We should ask if they have remained current enough to guide the company through these radical transitions and be a part of plotting a course for the future, or does the board need new blood? Is it time to go?

More With Less

Most early-stage companies are finding that reaching profitability has become critical in their quest to find financial investors. Gone are the days when investors were satisfied to fund losses while businesses matured and experimented to find their footing. There are sector exceptions like many of the AI platform developers, but the general investor sentiment is a return to fundamentals and insistence on positive EBITDA. In fact, many investors simply will not look at a company if it is EBITDA negative, no matter how solid the concept is. 

Today, we blame everything on AI, and this evolution is a reflection of at least two AI influences. AI has disrupted many elements of the tech industry, and in particular it has introduced uncertainty in pricing, gross margins, and operating costs. The result is a return to fundamentals for evaluating the economics of emerging businesses. Investors want to ensure that the unit economics will result in an acceptable and predictable gross margin, and they want to know that the business is operating in a capital efficient manner to create profitability with meaningful growth? 

The second AI influence is a bit less obvious. The pace of innovation has dramatically increased as AI is accelerating the engineering process required to create new capabilities, and simultaneously it is democratizing engineering so that almost anyone can build a new application in no time. I recently attended a presentation where one of the speakers announced that his company had stopped buying enterprise software. He claimed that on their own they could easily create whatever custom applications they needed. He implied that ‘do it yourself’ was more cost effective and more likely to meet their unique needs. This is a very extreme position, and doubtful if it is true, but it highlights the tenuous nature of investing in an application software business. The heightened risk that a company’s application will be obsolete before there is an opportunity to build a valuable business is forcing financial investors to become less risk tolerant. The business has to make economic sense before an investor will risk funding its growth. We used to say that ‘positive EBITDA will set you free,’ meaning that once a company reaches positive cash flow and/or profitability, the pressure shifts from survival to strategic success. Today, positive EBITDA is only the starting point.

The mantra that this focus on profitability is creating is a mindset to do more with less; much less. AI is making the product development cycle more efficient, and is streamlining all areas of business. One firm proudly announced that it had terminated its entire digital demand-gen department and replaced it with AI tools that were generating much more targeted traffic and leads at a fraction of the cost. This type of transformation is happening across the operational landscape.

CEOs and leadership teams are taking up the ‘do more with less’ battle cry, but often it is just that, a pronouncement without any real guidance to the team about how to do better, not just do less. We are seeing a mini-generational variance between companies that came into existence more than five years ago compared with companies that were born in the current age of AI. Five year old companies are broadly still early-stage businesses, but they formed in the time before the AI explosion, and staffed up in traditional ways. These are the businesses that are being forced to change their ways and downsize their costs to race to positive EBITDA on a new and faster trajectory than they were originally tracking. Too often, leadership has difficulty acknowledging just how much bloat is in the business, and just how much smaller it will need to be, and how fast it will need to get there. Like trying to lose body weight, we reach plateaus, and our body wants to return to its earlier weight as if it has a mind of its own that is resisting the concept of losing weight. Businesses built in one operational model resist shifting to a new operational model. 

Management often tries to reduce costs incrementally without fundamentally redesigning the business. They try to cut as much as they think is possible while still performing all of the same tasks and getting the same work done. Cuts are never quite deep enough because management is asking the wrong questions. Instead of asking how much cost can we remove, they need to ask how the business can operate completely differently, leveraging all of the new AI tools available. 

To run faster, farther and more capital efficiently, businesses need to commit to change. They have to ask how doing business differently can increase the pace and raise the quality of what everyone does. They need to reimagine the business to spend less time in meetings, but get the information in a different and more efficient manner. They need to rethink how they build and deliver products and services. In short, they need to question everything. It requires a commitment to introduce new standards and processes that will streamline work across the board. There is an old saying “lead, follow, or get out of the way,” which has to be the watchword for CEOs and management teams. Challenge the creativity of the team to find new paths forward for the business. Lead by insisting on fundamental redesign, not just incremental cost savings.

Chaos is Where The Magic Happens

The tech market and the investor community are foaming at the mouth about the impact and implications of AI. Every podcast, white paper, blog, and forum is awash with conflicting opinions on how AI is either going to destroy the tech industry or expand the markets infinitely. It is either the end of tech investing or the beginning of a new era. It will either eliminate all jobs, or it will make all jobs better. This is the SaaS-pocolypse and the death of all SaaS companies, or it is the rebirth of SaaS companies. The bottom line is that we are currently in a state of AI confusion and chaos.

While it is certainly a challenging time for business leaders and investors alike, my favorite concept is that all creative solutions come at the interface of chaos and order. Albert Einstein, Steve Jobs, and Nikola Tesla all emphasized that creativity involves making order out of chaos, but Mary Shelly (of Frankenstein fame) probably said it best when she noted that “invention does not consist in creating out of void, but out of chaos,” suggesting that the creative process involves seizing the potential within disorder. Chaos is where all the magic happens. Out of the AI chaos we are starting to see new areas of order emerge and take shape. I recently attended a CFO meeting where the discussion centered on how to properly code and account for AI costs both in costs of goods sold and in operations. As accountants standardize the mechanisms for tracking AI costs, the analysts are forming new frameworks for calculating performance metrics. As an example, one model suggests we calculate dollars of revenue per dollar of AI spend as a ratio that should be increasing in a business that is scaling and becoming more AI efficient. Historically, human resources have been the largest cost element in software companies, followed by systems and computing costs. We now have rapidly rising AI costs that in some companies have eclipsed the baseline computing costs. Hence, as we look at revenue per employee, we should also consider revenue per AI cost. 

My favorite topic has been the variability of AI costs and how this adversely impacts gross margin, particularly if it is being deployed as a component of a customer facing product. Companies that are heavily AI-forward in their product offerings are currently experiencing dramatic incremental costs of goods sold, which is leading to reduced gross margins. By some estimates, a 20% reduction in gross margin, or more. One of the accounting suggestions is to track the AI contribution to COGS and separately report baseline gross margin excluding AI costs and net gross margin including AI costs. This provides a view of base unit economics and enables analysis of the impact AI is making on the business.

With lower gross margins, there is less money to cover operating expenses and still maintain profitability. Savvy companies are focusing on productivity gains, particularly in engineering costs to build and support their products, as their way to absorb the decreased gross margin impact. Some analysts are betting on AI costs decreasing as the industry scales and becomes more competitive. In my humble opinion, I think that is a long way off. We are seeing AI companies make massive investments in infrastructure and research, and they are scaling their pricing to pass along costs by either charging a higher fee for tokens, or changing the equation so that solving the same problem consumes more token to complete. At the same time, application vendors are expanding the role of AI in their products, which is leading to increased demand for tokens, so even if the cost of tokens declines, vendors will still experience rising AI costs based on consumption. The structural change I see on the horizon is a rapid move toward consumption-based pricing for customers of the application vendors. Vendors cannot absorb the expanding costs of AI that they are delivering to their customers, so the only answer is for customers to bear the cost. CFOs and procurement managers are loath to accept variable consumption pricing, but it seems inevitable that these attitudes will have to change.

We are already seeing this shift as several giant SaaS vendors are renewing licenses with built-in token costs and escalators when a customer exceeds their included tokens. Vendors are delivering these new licenses with estimates of what a customer’s consumption will be, but most customers are already realizing that they will greatly exceed the estimates provided. 

The bottom line is that once we know how to instrument the new forms of AI-enabled businesses, we can learn how to creatively drive order from the current chaos. Vendors are figuring out how to manage their profitability in the age of AI, and they are also figuring out how to institute changes in the way they price and grow revenues. We are not out of the chaos of AI, but we are approaching the boundary between chaos and order where all innovations emerge.

Fear Or Greed

I recently saw a post that quoted George Bernard Shaw, who said “Two things define you: your patience when you have nothing and your attitude when you have everything.” It reminded me of a description of investor behavior when a company approaches the decision to go to market for a corporate sale or financing. Often, at this moment, financial investors exist in only one of two states: Fear or Greed. 

Following an initial investment in a venture there is usually euphoria and enthusiasm about the bright future ahead. That quickly turns to cautious optimism if things are going well, or pessimism if the venture is not quite living up to expectations. While the business is progressing, investors exhibit the full range of emotions, but generally they remain supportive and encouraging toward management. However, once the decision is made to sell the business, or seek additional new funding, things change.

If the decision is being driven by needs that have arisen due to under performance, then the dominant emotion is fear. Investors fear that they will not get a satisfactory offer, or worse, they will be forced to invest more money or risk losing their investment. Fear and uncertainty drives doubt and cautious behavior which manifests itself in reduced expectations for valuation. We start to hear things like “we are open to all offers,” meaning we do not expect much, but let’s just get this thing sold. This is when the first part of the George Bernard Shaw quote becomes relevant, investors need “patience when [they fear that they] have nothing.” 

However, a funny thing happens the minute an external buyer/investor expresses interest. Fear immediately turns to greed. Whatever the offer is, “we can get more.” This is when the second part of the Shaw quote becomes relevant, and investors should check their “attitude when you have everything.” This whipsaw in perspective from fear to greed can leave management confused, and demoralized. If the company is struggling and looking for any port in the storm, and the investors have made their fear well known, a sudden turn to greed when a ‘port’ is on the horizon is at best confusing. Greed creates unrealistic negotiating positions, and puts the CEO in the awkward position of having to explain why the value is what it is, or forces the CEO to undermine an offer with aggressive negotiations because the investors have become intransigent. 

A better path is to hold a board discussion at the start of the process to agree on the parameters of what will be an acceptable transaction, and what the alternatives are if an acceptable offer does not materialize. If a banker is involved, they can be helpful to guide the conversation with comparable deals and current market conditions. Unfortunately, bankers often paint a rosy picture to entice the company to sign up, like a realtor telling you your house is worth more than it actually is, but the banker is at least a somewhat neutral referee to help guide the discussion. The key is not to overlook the warts. Every business has its weak spots that detract from its beauty (the warts). If you have ever gone online to see what your car is worth, most sites show the price for comparable cars, but then ask how many miles your car has been driven and what condition it is in. If you are honest about the dents and dings and worn out parts, the implied value of your car may be well below the average market price, but closer to reality.

The same is true about selling a business. Just because you show a positive trend with a few good quarters, if the performance before the good quarters was problematic, you have to recognize that it will influence a buyer’s perspective on valuation. If the company had outsized churn in the past, or has significant technical debt these are all warts. If the company was forced to slim its workforce to preserve cash or reach better profitability, and if it was done close to the sale process, it is often viewed as an attempt to put lipstick on the pig, and the positive result is discounted. There are any number of weak spots the board needs to acknowledge that may result in an ultimate transaction value below the top quartile of market comps. The purpose of the honest assessment is not to become pessimistic and give the company away. Rather, it is to be clear eyed about what you are selling, and to establish rational expectations and behaviors when the impulse will be to flip from fear to greed. When everyone is on the same page about an acceptable outcome, the deal will invariably go more smoothly.

How Can We Help?

As a non-executive independent director, I am always conscious of what value I bring to the business. Some board roles are typically filled by executives, and in the private sector tech world, most of the remaining seats are contractually filled by investors, so if there is an independent seat, the independent has a unique position and role to play, and it is important to make a meaningful contribution.

I have recently been engaged with several companies in various stages of launching a process for a change of control liquidity event (sell the company), and this topic of meaningful contribution has been playing in my head. Once a company starts down the path to a sale, particularly if an investment banker has been engaged, the role of the board changes dramatically. 

If the likely buyer is a financial institution, then the sale will be a change of control, and some form of the business will live on. However, a new majority or one hundred percent owner will certainly make changes to the board, which will lead to changes in strategy and direction. If the likely buyer is another company purchasing for strategic reasons, then the board will be dissolved and the business will be absorbed into the acquirer. In any outcome, the board is changing, and the board members days are numbered.

Therefore, once a sale process is initiated the most obvious change is that the board’s planning horizon shrinks dramatically. Rather than discuss the strategy and direction of the business for the future, the aperture narrows to the timeframe of the sale process. The board only needs to focus on guiding the business as a going concern up to the point of sale. But, isn’t that management’s job? So that raises the question, once the decision is made to sell the business, what is the purpose of the board beyond ultimately approving the deal?

The members of the board who represent institutional investors have the benefit of having been to this movie before. They or their firm have been through multiple sale processes and that experience can be very helpful to the CEO. Hopefully, the same is true for the non-executive independent director(s). Board members know bankers and lawyers and advisors, and they know what to look for in each relationship. They also know the pitfalls and challenges involved in getting a deal done, and important nuances to negotiate. The sale process is a time to leverage the board for all it can provide, but too often, it becomes a time when the board retreats and the CEO goes it alone.

One benefit of engaging the board became evident at a recent meeting. The company had struggled to narrow their message about the unique value of the business, and how to present it in a compelling manner to potential strategic buyers. The CEO decided to preview the management presentation with the board for feedback. It was a great use of the board. As one board member put it “I have seen thousands of pitch decks. This is something I can help with.” 

Once the decision is made to head down the path to a corporate sale, board members are no longer making a long-term strategic contribution, and management is firmly in charge of the day to day operations leading up to the sale, so it is easy for the board to ‘stay informed’ but stop contributing. A sale process is very taxing on management and the CEO. They need to continue to run the business and meet targets, while also dealing with the activities and crises of the sale process. Inevitably, word leaks out in the company, and management will also have to deal with the cultural impact on the team. In my view, deal time is when the board needs to shift their focus solely to supporting the CEO in whatever capacity will be helpful. It could just mean giving the CEO more space by reducing the number of meetings and phone calls, or it could be assisting with the pitch deck, or managing the banker, or whatever will be helpful. The important thing is to not just check out and abandon the CEO.

The simple starting point is to ask “How can I help.”

Four Horsemen

I recently read “Outlive” by Dr. Attia, a book about longevity and wellness. In the book, he identifies four key areas that will ultimately lead to healthy longevity or set a path to unhealthy later years and premature death in all humans. He calls them the ‘Four Horsemen,’ referring to the four horsemen of the apocalypse from the New Testament. It made me consider a similar collection of key areas of corporate health that I believe lead to longevity and success or early corporate death (bankruptcy and decline). Here is my business version of the Four Horsemen:

1. Market Fit — Whatever business you create, you have to deliver something someone wants to buy. The phrase ‘will the dogs eat the food’ is a reference to launching a product that simply will not sell because nobody wants to buy it. Thinking about this Horseman through the lens of longevity expands the definition considerably. To build a sustainable business means you need to create an engine that produces offerings that people want to buy. This speaks to investing in innovation and market understanding. It also requires the business to make strategic decisions about choice of market. Investors look at ‘Total Addressable Market’ (TAM), which is the total potential set of buyers a company could possibly reach. If the TAM is too small, the business may flourish for a brief moment, but it will run out of people to sell to. Market Fit encompasses the product offerings, the market selection, the channels to get to market, and the sustainability of the engine to create new and improved offerings. If a company does these things poorly, the business is ultimately doomed.

2. Execution — There are lots of good ideas and well made plans, but if a business is consistently bad at execution, it has no hope of success. Execution is the ability to say what you are going to do, and then do it when and how you said it would be done. Businesses are complex machines with many interconnected parts that all come together to generate success. If some parts are unreliable or fail, the machine will grind to a halt. Even companies that excel at defining Market Fit (the first Horseman) will fail if they cannot execute. Execution is a discipline that leads to predictability. Companies that are good at execution typical have great respect for accountability and commitments in every aspect of their business. A byproduct of excellence at execution is customer satisfaction. When customers know they can trust and rely upon their vendor to deliver as promised, satisfaction scores go up. Execution also has a direct impact on the next Horseman —Culture, because it leads to a team that knows it can rely upon each other and it avoids the internal blame game that emerges from sloppy execution. As with Market Fit, a company that makes Execution a skill will be positioned for longevity and success, but one that consistently fails to execute is ultimately doomed.

3. Culture — This is the softest Horseman, but it underlies who a company is. We easily differentiate places that have a ‘toxic culture’ from the ones that are ‘a great place to work.’ Culture plays a role in recruiting and job satisfaction, and we know that ‘happy employees make happy customers.’ Many companies try to define their culture by publishing corporate values statements, but culture is derived from actions, not printed words. A strong positive culture will support a company through hard times, while a toxic or negative culture can destroy a healthy company. I originally trained in biology, and I remember growing bacteria on petri dishes. If we were careless, there was no telling what would grow on the dish, and usually the invading bacteria would destroy the experiment. To foster the bacteria we wanted to grow, we had to carefully tend to each petri dish and protect it. Business culture is no different. If we do not carefully tend to it and make it an intentional priority, there is no telling what culture we will get. As in my biology example, once a bad culture takes root, it is extremely difficult to eliminate it, but a positive culture will support longevity and success.

4. Finance — I saved this Horseman for last because it is the most obvious one, and it is the one that everyone recognizes and typically fixates upon. Of course, if financial and operational controls are bad, the business will likely fail. However, when we think about longevity and success, we have to go beyond accounting and measuring a point in time. In the book ‘Outlive,’ Dr. Attia describes a number of items like cholesterol or muscle mass that manifest themselves as problems in old age, but the seeds of the problem actually started long ago with unhealthy habits during earlier years. The Finance Horseman is similar. Looking narrowly at accounting, if we get the general ledger wrong at the start, it becomes a problem that is very hard to untangle years later. If we erroneously recognize or record revenues or expenses and create inaccurate financial statements, we inevitably make bad financial decisions that will become apparent in the future. But, this Horseman has even broader implications. 

Similar to blood tests that let doctors know what is going on in our bodies, financial metrics are indicators of what is going on in a business. Focusing on business health, longevity and success, I have a few favorites. First is Unit Economics. This measure represents the micro-business model for the delivery of one incremental unit of the company’s goods or services. It compares incremental revenues and costs, and tells us if delivering our good or service is actually a positive contributor to financial success. It answers the question “can we make up the loss in volume.” We want positive unit economics, and we would like to see this as an improving metric over time. We all learned you cannot outrun bad unit economics during the .com bubble.

Next up is Profitability. This is obvious, but I focus on two diagnostics: gross margin and operating profit (EBITDA). Revenue less cost of goods sold gives us gross margin, which tells us what portion of revenue is available to fund operations, and is a macro indicator of how the unit economics come together. Improving gross margin reflects the efficiency of the engine for sales and marketing as well as control of the cost of producing the goods. Operating Profit is the next step in the flow that takes the contribution from Gross Margin and deducts all of the expenses of running the business that are not a direct part of the costs of goods sold. It reflects the efficiency of the overall business. Negative EBITDA is ultimately a killer when the cash runs out, so it is clearly a Horseman, but even if profit is positive, if it is minimal for too long, it is like a blood test that keeps showing that the patient is anemic. They are not really healthy, and they do not have the energy to thrive. Similarly, anemic profits over time limit the business’s ability to invest and thrive, and indicate that the operations are not very efficient at delivering a sustainable and successful outcome.  

Lastly, how we finance our start-up business and fund growth in the early years will have a profound impact in later years. Institutional investors (VC, PE, etc.) raise capital and invest that capital in promising companies. They are not forever investors, rather they expect to generate a return in a finite number of years. When an entrepreneur accepts an investment from an institution, it is as if they are stamping a “Best If Sold By” date on the CEO’s forehead. Within the timeframe of the investor’s fund, they will want to sell their position, which will mean a liquidity event for the company. That decision to accept an initial investment in the early years of a company will materialize in later years to stunt longevity or shape future capitalization. Often, it strongly influences the company’s ability to invest in opportunities that will require nurturing beyond the investor’s hold period. Long-term capital planning and alignment with investor goals is critical. The Finance Horseman is the easiest to measure and ultimately establishes the success and longevity of the business. 

As with the four Horsemen that set the path for our personal health and longevity, the four business Horsemen described above set the tone for long-term success or failure. The earlier the CEO and Board focus on the trajectory for the business Horsemen, the more they are able to establish a sustainable and valuable business. Ignoring the business Horsemen, just like ignoring your cholesterol level or your blood pressure, will ultimately put the business in peril.

Create The Space To Lead

A lot has been written about founder entrepreneurs remaining at the center of the company’s universe for too long. Initially, it may be necessary for the entrepreneur to make all decisions and manage or perform all activities, but when their business starts to grow and take shape, they need to make room for others. There is a difference between the ‘scale up’ and ‘grow up’ phases of growth. In the scale up phase, the business is adding bodies to get the work done, but not necessarily filling out the leadership ranks to strategically position the company for the future. As an example, think of the entrepreneur who creates a widget for sale. Initially, as orders come in, the entrepreneur can fulfill them in her garage, but when the business picks up, she needs to hire people to help fill orders, and maybe she needs to rent a space and move out of the garage. This is scaling up, but not necessarily growing up. The entrepreneur may still be doing and directing all of the activities, just working harder with a few extra bodies to help get it all done.

Growing up includes creating management and leadership roles, filling them with experienced individuals, and giving them responsibility and authority to succeed. As these changes occur, the entrepreneur CEO needs to step back and create space for the new leaders. This is much easier said than done, and many CEOs remain at the center of the company’s universe way too long. In so doing, they stifle the opportunity for leaders and managers to truly contribute, and they limit the company’s ability to mature. At the same time, this type of CEO behavior limits their own ability to mature and contribute in new ways. 

I have often written about the ‘tyranny of the urgent.’ This is the situation where urgent matters consume all of the available time and energy, and there is nothing left to address anything else. When a CEO ‘needs’ to be a part of every decision and involved in every activity, they quickly run out of time in the day, and the tyranny of the urgent becomes overwhelming. Some CEOs become addicted to the maelstrom of urgency and think they are heroes by staying on top of everything. The reality is that this behavior almost certainly is limiting the success of the business and the success of the CEO.

Stepping out of the tyranny of the urgent enables the CEO to create space to look around and see the whole picture of the business. When daily operations no longer consume the CEO, they are in a better position to contemplate the future of the business and actually lead the company forward, rather than tread water every day. CEOs need the space to lead.

The same is true for boards of directors. When boards become too operationally minded, they lose perspective. Board meetings that grind away at past financial performance and operational metrics are attempting to lead by looking in the rearview mirror. The more a board crosses the line into operations, the less it is contributing to building the foundation for sustainable success. Just as it is important for a CEO to create space to lead, it is important for a board to create space to truly be helpful to the CEO. For the board, it may mean taking a step back to consider their role and what they bring to the table. Companies grow through leadership phases, and boards need to grow with them. A best practice to create space is to periodically set a formal time aside to discuss the purpose of the board, and its contribution, and to ask the CEO how the board can be more helpful. The benefits of creating space can sometimes be quite surprising and lead to significant breakthroughs.

note: There is a book by Tutti Taygerly similarly titled “Make Space to Lead: Break Patterns to Find Flow and Focus on What Matters” which addresses more personal aspects of making space for one’s well being. It was not a source in any way for this post.

AI Ate My Job

Over the last year or two, we have seen record layoffs at major tech firms. Often, they have been attributed to AI investments. Digging a little deeper, not all AI-related reductions in force (RIF) are being driven by the same motivation. If we divide the world into three buckets: AI-Suppliers, Vendors, and Customers, we can begin to peel back the drivers. Of course, we have to recognize that in a supply chain, vendors are also someone’s customer, and customers are someone’s vendor, but for simplicity we can divide behaviors into these three camps.

The level of investment going into AI infrastructure is historic. AI-Suppliers are building massive data centers, and many more are planned. Other companies are investing billions to create AI platforms and models, and it feels like we are in an epic arms race to make ever ‘smarter’ and more capable platforms. Several of the traditional tech giants have been undergoing significant business shifts resulting in mass layoffs as they pivot away from investing in their traditional businesses and toward investing in new AI frontiers. Think Meta, Oracle, Microsoft, etc. These staff reductions make the news, and contribute to the perception that AI is crushing the job market.

Beyond the AI suppliers, however, it seems as though every vendor and customer alike is using AI in some manner to augment or operate their business or supplement the productivity of their personnel. The cumulative spend across all industries is incalculable. 

Vendors are all under pressure to incorporate AI-based features into their tech products. As discussed in earlier posts, this is introducing new costs into their products and putting pressure on gross margins in the form of added cost of goods sold. With reduced gross margins, there is less money available to fund operations, leading to the need to drive efficiency in operating costs. For most software businesses, the largest cost line item is personnel, so this is a natural place to look for savings. The good news is that AI has the potential to help employees become more efficient. The bad news is that as efficiency increases, businesses need fewer employees. However, the efficiency gains are not free, so as companies embrace AI-based tools to help their staff become more efficient, they also take on the costs of the new tools. The balancing act is to manage total spend by netting the cost of new tools against the efficiency gains and the savings driven by reducing staff. From the vendor perspective, one area where AI is specifically driving efficiency is the engineering department. Companies that ‘partner’ with AI to write and test code are seeing significant efficiency gains in the pace of product delivery. A skilled engineer can be three or four times more efficient by partnering with AI tools, while the added AI cost is closer to the human cost of just one new engineer. Three or four fold productivity gain for les than two times the cost. Fewer engineering jobs, but greater productivity, and on a blended basis, the AI cost plus HR cost is lower.

On the customer side of the equation, AI is permeating every aspect of running a business. The new applications the vendors are delivering are making their customers’ team members more efficient. The efficiency comes at a cost, but so far the cost impact is not that great because the inertia of existing license pricing is limiting how fast vendors are able to pass along their new costs to their customers. As I argued in an earlier post, this equation is likely to change as vendors move toward consumption pricing and customers are forced to pay for their AI benefits. 

Today, we see headcount reductions in the customer market primarily in entry-level or lower-paid roles. AI-driven platforms can efficiently replace humans performing elements of the sales development (SDR) role, marketing communications roles, and customer support roles. AI agents can efficiently do data gathering and analysis, and are becoming adept at producing reports and presentations that used to require human action. This is where the phrase “AI Ate My Job” is most apt. Unfortunately, this imbalance is creating a huge problem for new grads and those without experience entering the job market. With the elimination of entry level jobs, there is little opportunity to get on the job training and experience. Without experience, you cannot find a job to get experience.

Educational institutions are slowly adapting to this reality by integrating AI into the curriculum. We used to talk about generations that were ‘born digital,’ and comfortable learning how to operate technology. Now we are seeing a generation that is being ‘born AI savvy,’ and excel in the application of AI. These are the skills that traditional organizations need to hire in order to effectively embrace AI in their businesses, and this is where educational institutions need to adapt. We are also starting to see an ‘old dog, new tricks’ problem emerge as experienced employees who are used to doing things the ‘old’ way find it difficult to transition to the new way things are being done.

It may be true that AI ate some jobs, but it is also creating new opportunities. We are in a transitional period that will be very disruptive for many people. The pace of change is dizzying, but as has been the case with all technology transitions, things will eventually settle into a new normal. What feels different is the pace of change being introduced by the breathtaking advances in AI. The pace of technology advancement is accelerating, and the workforce will have to keep up or be left behind. AI may eat some jobs and close some doors, but in time it will also open new ones.

The AI Pricing Squeeze

The last few posts addressed changes in the tech world driven by the AI revolution. Everything from staffing to usability and ultimately to business valuation has been thrown into chaos. We are seeing fundamental changes in the way software companies operate that result in very different cost structures, and we are seeing investors focus on different financial metrics that reflect what a good AI-driven business should look like. For software companies, SaaS metrics are still relevant but not necessarily sufficient to truly understand the health of a business. There is a lot of inertia in a large-scale SaaS company that can mask the impact AI is having on their business. Recurring contracts represent the majority of SaaS revenue, and this flywheel has historically made SaaS businesses so valuable. However, the recurring revenue inertia may be masking shifting fortunes as AI permeates the market. Replacement cycles are shrinking, add-ons are becoming less valuable, and as customers reduce their staff, the number of users is declining. We can see the reduced expectations in lower public market valuations for the largest SaaS vendors (Salesforce.com, HubSpot, etc.).

With these headwinds, companies need to assess their approach to embracing AI tools. Many companies have taken a 1+ approach to AI. They start with all of their existing staff and costs, and add AI tools and capabilities on top of their current expense base. Like a street drug, initially the AI costs are small, and the benefits seem magical. As adoption grows, the costs quickly grow, and the margins start to decline. AI tools make everyone more productive, but they also make them more expensive. If an engineer can become more productive using AI, but the AI costs are equivalent to adding another human, unless the company budgeted for the extra costs, there is going to be a problem if the productivity does not translate into increased revenue. We are seeing layoffs and redundancies across the board as companies recognize that productivity gains come at a cost, and prudent financial management requires companies to right the ship. 

The real challenge on the horizon is the squeeze businesses are facing as they deliver natural language and AI-driven interfaces to their customers. We have all become enamored with conversational application interfaces. We can simply ask a question and the interface will figure out what it means and how to answer it - magic. Behind the scenes, the AI engine is burning through tokens that cost the vendor money. Traditional licensing models are based on fixed pricing that is tied to something like number of users, and behind the scenes the vendor’s computing costs to deliver the results are well understood. Buyers want predictable costs that they can rely upon to secure budget approval for purchases, vendors want predictable computing costs, and CFOs on both sides do not like unpredictable expenses that fluctuate wildly. However, vendors do not have a good mechanism (yet?) to predict the AI costs of their customers’ random use of AI-based interfaces. The result is that vendors are caught between a rock and a hard place, needing to offer fixed, recurring contract pricing that is predicated on randomly fluctuating costs to deliver.

The beautiful SaaS model of committed recurring revenues that was the foundation for valuing SaaS vendors, is now creating an impediment to predictable profitability and business health. The answer is going to require a shift in application pricing. Back in the days when SaaS first appeared, recurring license models introduced a shift from one-time up-front perpetual licenses with small fixed annual maintenance fees to an annual recurring license cost. Vendors initially met significant resistance from business buyers, but eventually CFOs accepted the new reality, and the SaaS model became the standard. So too, we are now going to see a shift toward consumption-based or transaction pricing. It is currently evolving as a hybrid price structure. Vendors are charging a SaaS-like fixed license fee for their platform that includes some level of consumption or usage, but beyond the included activity, the buyer will be charged for consumption. On the vendor side of the equation, the fixed license fee will fund the operational costs of the business, and the consumption fees will cover the variable AI engine costs (plus a margin). 

How long the hybrid model lasts will depend upon how the winds blow in the marketplace, and how AI pricing eventually settles down. The historic progression of pricing models in financial institutions provides a picture of this type of dynamic. When the cost of stock trades was high, brokers required minimum 100 share transactions, and the fee for trading was their primary source of revenue. As the cost to trade decreased, discount brokers permitted trades in any increment, and full-service brokers shifted from trading fees to asset management fees, with ‘free’ trades included. A primary driver underlying the shift was the declining back-end cost to execute a trade. A similar shift occurred in cell phone pricing. Initially, minutes were costly and consumer contracts were comprised of a base fee that included some minutes, and a per-minute charge for overage. When competition drove down the cost per minute on the backend, consumer contracts became fixed with unlimited minutes. Similarly, the AI cost of buying and consuming tokens will determine pricing behavior in the application vendor market. If AI costs become de minimus, we will see a return to platform pricing - not unlike cell phones carriers moving to fixed pricing for unlimited usage. If AI transaction charges continue to grow and remain unpredictable, we will see increased pressure to shift toward purely consumption-based pricing.

The focus for application developers must remain on business fundamentals. In particular the guiding metrics should be gross margin and operating margin. Gross margin reflects the revenue collected in comparison to the cost of goods sold. With AI costs fluctuating and consumption pricing evolving, vendors need to stay on top of the blended revenue and the blended COGS to preserve their gross margin available to fund the business. On the operating costs, once again we will have a blended people plus AI cost structure for each functional area of the business that adopts AI-based productivity tools. People costs and AI costs will become fungible, so we need to manage the total operating costs and insure we preserve operating margins. That means harvesting gains in efficiency by offsetting the AI costs against the traditional costs which unfortunately may lead to staff reductions. Companies that make the hard decisions to rebalance their costs to align with their productivity will be positioned to thrive and generate profits. Companies that lose sight of their gross margin and operating margin are doomed to under perform and fail.

Buckle Up!

We are living in uncertain times. The geopolitical landscape is chaotic, and the ripple effects throughout the economy are challenging at best. Tech entrepreneurs have the added uncertainty driven by the implications of AI, and the resulting skittish buying community. In my last post, I quoted Yogi Berra “The future ain’t what it used to be,” and I heard a lot of feedback from CEO friends.

What was most concerning was that several CEOs were quite fatalistic about the prospects for the future. They pointed to imbalances in the economics of innovative technology companies that will lower their potential valuation and significantly raise the bar to reach sustainable financial success. Here are several of the issues they raised:

• Special Sauce - Every successful company needs a unique value proposition and defensible competitive differentiation — their special sauce. As one CEO put it, we can think about a software product in terms of three layers: data, application logic, and interface. An AI-based natural language interface layer has become nearly ubiquitous across applications. In just the last year or two, the ‘gee wiz’ of being able to ask questions or give directions to a platform in natural language has vanished, and it has become table-stakes for nearly every product. In other words, it has become hard to defend a competitive differentiation with a cool interface. 

At the same time, it has become much easier to create application logic using AI tools. The pace of delivering capabilities has accelerated, so the longevity of competitive differentiation has diminished. What was easy for you to build will be easy for a competitor to cover. There is still value in subject matter expertise, but the scale of the engineering effort is no longer the competitive barrier.

So that leaves the data layer as the last potential competitive barrier. This one is interesting because companies with deep, proprietary troves of data have a unique asset that has value and may be defensible. Additionally, with AI tools, companies that have a deep data trove can mine it to effectively turn it into a competitive advantage that start-ups with a bright idea but no historic data cannot match. The potential counter to this argument is the ready availability of publicly-sourced data and agent-based tools to access and integrate it. My bet is on the companies with rich proprietary data, but time will tell.

The bottom line is that it is becoming increasingly difficult to defend a unique value proposition and competitive differentiation. As a result, it is challenging to outpace competitors and consistently grow at a rate that will attract a high valuation. 

• Stickiness - In a recurring revenue relationship, customer retention is critical. It is not uncommon for SaaS companies to spend as much or more than the first year’s revenue to acquire a customer. They are betting on client retention in subsequent years to be the source of profits. We calculate the lifetime value to customer acquisition ratio (LTV/CAC) as a key SaaS metric. However, in the evolving AI-driven market, customers are less sticky. The replacement cycle has accelerated. With natural language interfaces, the barrier to learning a new system is lower, and with agentic activity management, the level of user-learning and involvement to accomplish tasks is lower. The result is buyers can hop from one application to another fairly easily. 

• Profit Margins - So far, AI-driven companies are just not that profitable. Typical SaaS companies have better than 80% gross margin, and once they are established they can generate decent net income. AI-based companies have a different cost structure, most have gross margins well below 60% and underperform significantly on net income. AI requires massive computing costs and pricing models have not settled into predictable patterns. From the vendors’ perspective, consumption-based pricing seems to be the only way to manage costs and preserve margins, but many corporate buyers struggle to budget for unpredictable consumption costs, particularly when no one can explain how actions equate to consumption. The whole token-based AI pricing model is so complicated and unpredictable that application software companies are being trapped between customers that want a simple predictable licensing fee, and AI costs that are eroding their gross margins. Lower margins and profitability equate to lower enterprise value for raising capital, and lower value on exit, which is not an attractive model for investors or entrepreneurs.

• Pivot - What most entrepreneurs are facing is the need to pivot their business strategy and model to incorporate the new dynamics introduced by AI. They need to figure out how to skate to where the puck will be, which may be a very different trajectory from how they have structured their business to date. Investors who made investments in the last five years are seeing expectations evaporate. Going forward, investors need to change their criteria and investment models to reflect the evolving new realities, but at this time, things are still pretty unsettled, so it is hard to predict what an investment made today will look like five years from now.

The best defense for entrepreneurs and investors is to return to fundamentals and manage a solid business every day. We see this in the dramatically increased focus on cash flow and positive EBITDA. Gone are the days when investors tolerated losses in search of growth at any cost. Unit economics and capital efficiency have become the principal metrics, and growth goals have become more modest. At the same time, we are seeing declining valuations and reduced expectations for multiples at exit. The net is that the landscape has become less attractive for entrepreneurs and investors. The message from the CEOs I spoke with recently was that launching and growing a tech business was already hard work, but the task has become even more daunting, while at the same time potentially less rewarding. The market will sort it all out in the next few years, but for now we are going through a transition that is exciting on one hand and frightening on the other. Buckle Up!

The Future Ain’t What It Used To Be - Y. Berra

I was struck by a few quotes and posts this week that centered around the future of the application software business. Several investor friends wrote about the changing topography in application development leading to a changing landscape for venture and private equity investing. 

What used to take lots of people to accomplish, can now be completed with the effective use of AI assistance and just a few people. An entrepreneur with deep subject matter knowledge but limited engineering skills used to have to rely upon a team of engineers to realize their dreams, but now they can deliver a meaningful embodiment of their idea with AI doing the engineering heavy-lifting. 

Sales and Marketing teams used to require SDRs to generate and nurture leads, but now AI bots do most of the work. Customer support has been similarly impacted, and even accounting functions such as accounts payable and accounts receivable processing have become AI enabled. The bottom line is that building an application business requires a lot fewer people, which has traditionally been the single largest expense. As a result, businesses need far less money to get going, and traditional SaaS investment metrics have become outdated. 

At the same time, the efficiency gains have also lowered the competitive barrier to entry. If something was easy for one entrepreneur to create, then it may also be easy for a competitor to emerge. The entrepreneur and potential investors need to be clear about what the special sauce is that will prevent the next competitor from just covering the innovation? A potential investor needs to balance the efficiency with which the entrepreneur launched their business against the defensibility of the market position. It is not just about capital efficiency anymore. 

A third trend is an increase in the pace of innovation and replacement. The demise of the large-scale SaaS enterprise systems like Salesforce or SAP is greatly overstated. Mark Twain famously said, "The report of my death was an exaggeration," and the same can be said for enterprise SaaS. However, the add-ons and extensions and vertical-specific applications are a different story. We often differentiate products as either vitamins or cures. A cure is a foundational application, while a vitamin makes things better. The vitamins are under pressure as a result of the changing dynamics leading to accelerated innovation and replacement. Buyers are not as invested in their ‘vitamins,’ and when a new one comes along it is easy to switch. Creating new ‘vitamins’ has become easier and faster, so switching is accelerating.

A quote from Yogi Berra sums up the bottom line “the future ain’t what it used to be.” During this transitional period, while we are all adjusting to the pace of change, I’m reminded of the great movie title “Back To The Future.” It made me think about the fundamentals of prior tech eras and what guidance they can provide now. One of my favorite adages is “too much money makes you stupid.” Investors are in the business of deploying capital, and when they find a promising business opportunity they want to fuel it with money to help it grow and increase in value. Unfortunately, when a business takes too big of a slug of new capital, it can bring out the stupid. 

The less money you have, the more often you count it, and the more you worry about conserving it. Some of the most successful businesses bootstrapped their early years and resisted accepting outside capital until the business was mature enough to deploy it wisely. Admittedly, it may have held back their initial growth and market dominance, but there is a lesson for the current market. Today, businesses do not need as much capital to get going, and as discussed above, it is more important than ever to prove that the foundation is defensible before pouring on capital to scale. 

I have noticed an interesting phenomenon in companies that raised lots of money and then hit hard times. When the investment spigot was shut off and the bank account dwindled, these high-flying companies started cutting back operating costs. For most, the initial cuts were rarely deep enough, so things got worse. However, the companies that responded by performing a deeper analysis of their unique value proposition and strategic direction, and concentrated on only funding the core of their business, were able to make the right cuts and emerge stronger than they ever were when they were awash in money. In fitness circles, the phrase is “no pain, no gain.” These companies discovered that they had too many boil the ocean efforts underway, or way too much anticipatory hiring before the business actually needed the scale. With lots of cash in the bank, they lost sight of the profit motive and attempted to buy their way to growth, or “gain” with no “pain.” It was not until they felt the pain of actually creating a sustainable business that they earned the gain. All of this is reminiscent of the dot com bubble era where we focused on all the wrong metrics and bought what we thought was success.

The lesson for the modern era is to recognize that the innovation and funding equation has changed, and so has the competitive landscape and defensibility of bright ideas. We have to rethink what the real competitive moat is, and recognize that the obsolescence schedule may be shorter than we think, and therefore the investment return may not align with prior expectations. “The future ain’t what it used to be.”

Mind The Drift

In my last post, I wrote about ‘Passion or Paycheck,’ and how it impacts executive team turnover. I had a few conversations with executives about employee turnover in general, and how what appears to be isolated decisions may in fact be linked together with a through thread. When a company is a visible leader in its space, it becomes a target for recruiters seeking to hire away the magic on behalf of competitors. It is easy for a leader to dismiss a string of employee decisions as independent choices that individuals are making for their own personal reasons. You can justify the exits as pursuing exciting new opportunities for career growth. After all, your company is doing well, so why else would anyone choose to leave?

In fact, before someone decides to entertain an opportunity to move on, they generally have a kernel of vulnerability. There is some reason nagging at them that creates an openness to the conversation. Frequently, the vulnerability grows out of assumptions about the company or thoughts about career opportunities internally or issues with one’s manager or department. Once again I turn to the words of Andy Grove from Intel, “Only the paranoid survive.” As the leader, your managers may tell you the exits are unavoidable and not connected, but after a few, your paranoia should kick in. No manager is going to come to you to acknowledge how their own failings may have led to employee exits, and yet we know that the single most determinate influence on employee satisfaction is their manager. If there is a cluster of exits in one area of the company, it is time to do some investigating.

Sometimes, there does not appear to be any pattern to the employee exits. They are popping up across different departments or areas of the business. It is easy to treat them as unfortunate random occurrences. But, healthy paranoia should prevail if the number of exits or the frequency seems to be changing. Companies are complex organisms with multiple pathways for internal communication. There are the formal channels that come from HR or leadership, but often the stronger pathway is the informal communication between employees - the rumor mill or grape vine. Like a waterway, if a poison is introduced someplace upstream, it will eventually flow downstream and contaminate everything. So too with the company grapevine. When someone expresses a negative or cautionary thought it will get passed around and ultimately creates a vulnerability for an individual far removed from the originator. Along the way, the ‘poison’ may have rattled an untold number of team members, and eventually it starts to manifest itself in a cluster of employee turnover.

I have written in the past about the concept of the Ladder of Inference. The idea is that when one individual jumps to an erroneous conclusion, the thread of thought gets amplified and expanded by a series of subsequent inferences that eventually blow up morale. The best example is a company that has a policy of having bagels delivered every Friday morning for the team to enjoy. 

One Friday, the first employee to arrive notices that there are no bagels in the break room. They tell their friends and they start to speculate: 

• There are no bagels. I wonder if the company cancelled the perk and did not say anything?

• What if they did not pay the bill?

• Maybe they could not afford to keep giving them out?

• I wonder if this is the only cut back?

• I bet the next step is a hiring freeze and probably layoffs!

• I had a call from a recruiter that I was ignoring, but maybe I should call back!

• Wow, if there are going to be layoffs, I better get my resume out!

• Let’s tell the others that the handwriting is on the wall!!!

Eventually, the admin in charge of the bagels shows up with a sign that says “Sorry, the bagels are late this morning because the delivery truck broke down. Please come back in an hour.”

In the absence of information, employees quickly climb the Ladder of Inference, and it takes clear corporate communication to de-escalate. Similar to the missing bagels, when team members see other team members leaving, they start to climb the ladder. FOMO (fear of missing out) leads them to suspect that the people leaving know something they do not know, and they do not want to be the last to learn whatever the dark corporate secret might be.  

A leadership tool I learned years ago was to pay attention to the “Drift” in the company. Drift is the unwritten, unsanctioned sentiment that is floating around the halls and offices. Usually, it is the conspiracy theories and rumors that employees loosely know and rarely share with execs in a formal manner. As a senior executive, it is important to actively listen for the drift. What I found was that we could usually crowd source our understanding of the drift. Each senior manager and executive was able to pick up on some aspect of the drift. It may have been from conversations among members of their team about some other team, or offhand questions that seemed out of character. Everyone in leadership had a piece of the puzzle. To piece together the mosaic overall picture of the drift, we made time in leadership meetings to specifically talk about the drift. Each participant in the meeting shared their latest discovery, and as a leadership team we could put it together to build a picture of employee morale and trouble spots. It informed us of negative inferences that needed to be squashed, and of worries or concerns that were eroding confidence. The key was to make time to recognize and explore the drift, and then to address the issues in an open and frank manner in corporate communications.

As a leader, it is imperative to listen to your paranoia. Georg Lichtenberg an 18th century physicist said “One's first step in wisdom is to question everything - and one's last is to come to terms with everything.” Rather than ignore an uptick in employee turnover, acknowledge it and over communicate the facts in the face of the Ladder of Influence. Be open and tell the team that if they have nagging thoughts planting a kernel of vulnerability, they should start by confirming their assumptions. Provide the team with a safe mechanism to raise their concerns.  It they see business issues, they should test their interpretation by speaking with a manager or executive.

Passion or Paycheck

Launching a business is hard. Sustaining it is even harder, and sustaining growth is harder still. As a company grows, team members tend to fall into two broad categories with a lot of shades of gray in between. On one end of the spectrum are those for whom the job is just a job, while at the other end are those who are dedicated to the business and willing to do whatever it takes to see it succeed. We expect commitment to be directly related to monetary reward, and there is certainly a correlation, but it is surprising how many engaged and dedicated team members are in mundane modestly compensated positions, and how many well compensated senior contributors are only in it for a paycheck and a nine to five job.

The most devastating situation is when a member of the senior executive team professes commitment but turns out to only be in it for a job. As a CEO, you count on your executive team to share your passion, and you expect them to be your partners to lead the company to fame and glory, but sometimes, it is just a paycheck. It is important for the CEO to know which camp their key execs fall into - passion or paycheck. One of the worst days for a CEO is when a trusted lieutenant surprises you by announcing they are departing for another job. I often quote Andy Grove of Intel saying that “only the paranoid survive,” but some things you just count on and do not expect to need to keep looking over your shoulder to confirm. The loyalty and commitment of senior executive team members is one of those safe anchors, which is why it is so rattling when you are surprised by an exit. Often there is a sense of betrayal that accompanies the need for crisis management. The more senior the executive, the bigger the hole you will need to fill.

We want senior executives to be ambitious, and we want them to have fulfilling careers, but we also need to be aware of the passion or paycheck dichotomy. We need a sense for how an executive will react when a recruiter calls. An executive who rose through the ranks to a position of leadership reporting to the CEO is clearly someone with ambition. Unless the CEO plans to retire sometime soon, further career advancement for members of the executive team may be somewhat limited. Executive jobs get bigger as the company gets bigger, and maybe there are opportunities for advancement, but there is only one CEO (typically), and an executive with an ambition of becoming a CEO will sooner or later look outside the company. Not all execs aspire to the CEO role, and it is just as important to understand what makes them tick. Often the CFO or the CTO career path is more focused on their craft than on obtaining a CEO position. Restlessness for these executives may be triggered by boredom or desire to tackle bigger harder problems than the company can offer. Understanding the potential motivations, empowers a CEO to be mentally prepared for the inevitable, but more importantly it opens the door to an honest working relationship where the CEO works with each executive to prepare them and mentor them to achieve their goals, in exchange for fair warning when the recruiters come calling.

When a departure is a surprise, it is a violation of trust and commitment. If you have a face-to-face discussion about commitment and the executive looks you in the eye and tells you they are totally dedicated to seeing the company through and they are not going anywhere, you tend to believe them. If they come back weeks or months later and announce they are leaving, that is when it truly hurts. It triggers a moment of introspection about what you could have done differently, or how you could have seen the signs or anticipated the defection. Sometimes, there was no way to predict it, and the executive was just disingenuous when they professed commitment. However, often the handwriting was on the wall and you just overlooked it, or you created an environment that closed off the career conversation.

In the context of being ever vigilant and paranoid, as a leader you cannot take for granted that everyone shares your commitment. You need to create a safe space for your team members to express their needs and wants so that you can hear the message and see the writing on the wall. In a healthy relationship you can have an honest adult conversation about the path forward, and at least be prepared for the potential change to come. It is never easy to lose a key person, but when the individual does not feel an imperative to be secretive about their career goals and intentions there can be an open dialog about how to move forward. The key to avoiding a surprise termination is to maintain an open dialog and willingness to truly listen and look for the signs of discontent.

Thinking more broadly about the entire employee base, it can be very informative and beneficial to challenge every manager in the company to take a step back for introspection about their team, themselves, and the company as a whole. Ask managers to go beyond routine employee evaluations and performance reviews, and truly listen to their team members. Learn about what motivates each member and how the company can create an environment that sparks their engagement. Even a small shift in the engagement equation can have an outsized positive impact on the business. Challenge mangers to shift the equation, and find the spark.

Thomas Jefferson's Advice For M&A

My last post grew out of a Ben Franklin quote, so it seemed only fitting to follow with a post inspired by Thomas Jefferson. In the last several months, three of the companies where I participate as an advisor and board member, all decided to launch banker-led processes to sell their businesses. Jefferson reminded me of several aspects of the process that are important to keep in mind. 

Thomas Jefferson advised to make complex ideas simple to ensure they resonate with a broader audience. Businesses are complicated, and nearly every business encompasses a range of operations, some core and some context, and some that really do not belong. What may have started as a clear idea and inspiration, over time will often morph into a complex entity. The challenge when selling the business is to create a clear message and to simplify the complexity so that potential buyers know what is being offered. In order to craft a simple message, you have to know who you are speaking with. Just as in corporate marketing, you have to identify the ideal customer profile (ICP), and create a compelling message that resonates with the ICP. If there are multiple lines of business, what is compelling for one ICP may be a turn off for another. What may motivate a strategic buyer may have a different value for a financial buyer. There may be elements of the business that seem to make sense in an operating context, but nobody values in a sale process. I have seen instances where the buyer is willing to pay one price for the total business, but if the seller will eliminate a component, the buyer will actually pay more. The element in question was so offensive that the buyer knew it would be a distraction that would waste resources and complicate the corporate integration, so it actually had negative value and reduced the value of the deal.

A fuzzy offering with a complex description can be fatal to a sale process. Buyers have a hard time establishing a value when the business description is muddled due to misfit pieces. They assume the seller is thinking in terms of a simple multiple of the whole, but the buyers only value parts, so they conclude they will not reach a clearing price and back away entirely. Alternatively, if the business looks too complicated or nuanced, buyers may just not want the hassle of figuring it out. The same is true for investment bankers. Companies with complex or inarticulate business descriptions often have difficulty finding an investment banker willing to take the assignment. If the banker cannot understand the business clearly enough to articulate the strategy and value, then they know that the engagement will be challenging or result in offers below the owners’ clearing price, so it is not worth their time. Unfortunately, if a banker who does not fully understand the business decides to engage, everyone usually ends up frustrated. When the banker cannot articulate the strategy and value proposition, they resort to a numbers game. They create a book, send it to a hundred usual suspects, hope some of them figure it out and engage, then they focus on the financials rather than the strategic value of the business. Not a formula for a great outcome.

Jefferson also said that “good dinner makes good conversation.” He valued the conversation during meals as a unique opportunity to build understanding. The corporate sale process is a courtship leading to a marriage. To maximize value, the buyer and the seller have to get to know each other and build rapport. In our age of video meetings, we lose a lot of the opportunities to just spend time together and become friends and colleagues. Sharing a meal in an informal setting is an important element that can increase the likelihood of a deal and even increase the price paid. Never overlook the cultural component of getting a deal done, and the importance of the buyer and seller becoming comfortable with each other. I recently observed a process that came down to two serious buyers. The seller’s CEO and executive team spent time (and meals) with one potential buyer, and built a positive rapport. The other buyer stayed on video and focused exclusively on the due diligence rather than the culture. As the process proceeded, the seller’s team subtly and unconsciously conveyed their enthusiasm for one buyer and their lack of enthusiasm for the other. The offers ultimately were wildly different, with the favored buyer on the high end. Maybe it was a result of actual differences in perceived value, but I suspect the lack of ‘meal time’ and rapport building played a decisive role in the price disparity.

Jefferson famously said “never put off till tomorrow what you can do today," which emphasizes the importance of staying focused and taking action promptly. Deals are like sharks; if they are not moving forward, they are dying. Once a sale process begins, urgency has to be the driving force for the seller. Stuff happens. The longer things stretch out, the greater the likelihood that something will happen that adversely impacts the transaction. It could be something in the business such as an important client churns, or it could be a completely external macro economic change like tariffs, or conflict, or any number of unforeseen events. Do not leave any time for bad things to occur.

One last Jefferson quote to guide us through the sale process. As stated above, stuff happens while the process is unfolding. The objective of the due diligence process is to confirm truths and discover faults and weaknesses. For the seller, it is like being on trial, having to explain and defend decisions, results, conclusions, etc. For the buyer, it can be an alarming time when discoveries rattle your commitment to proceed with the deal. Jefferson advised to “always take hold of things by the smooth handle grateful that they are not worse, rather than the rough handle bitter that they are not better.’ With this saying, he encouraged a calm and constructive approach to challenges, and an optimistic positive attitude to move forward. He stressed the importance of leadership that balances inspiration with practical action. Diligence is a time when it is easy to become alarmed and act emotionally. Keeping the ‘smooth handle’ in mind provides the opportunity for calm analysis. In Jefferson’s view, “to learn, you have to listen. To improve, you have to try.” Good words to bring calm into the process.

Ben Franklin’s Guide For The CEO and Board

I was reading a book that referenced a quote from Benjamin Franklin, and I proceeded down the rabbit hole of related Franklin quotes chasing a lesson for CEOs and Boards of Directors. The quote that launched my quest was “Wise men don’t need advice, fools won’t take it.” I triggered on the word ‘need’ in the quote. Some of the wisest people I know are hungry for advice and opinions. They may not ‘need’ advice, but they welcome it. They listen and assimilate ideas as they contemplate a course of action, then they form their own opinion and act decisively.

In the dynamic between a CEO and the board of directors, this aphorism plays out every day. Often, CEOs feel they have to avoid any sign of weakness or uncertainty when interacting with their board. They assume that if they need advice, then they will be judged as suspect, but if they project that they are wise and do not take advice, then they will demonstrate that they are in control. They put on their ‘wise’ face and speak with authority and conviction, while closing the door to good advice. The result is that they are actually acting as the ‘fool’ by not seeking input and help. The ‘wise’ CEO may not need advice, but is open to receiving it.  

On the flip side, when the board is repeatedly ignored by the CEO or their input is unwelcome, the Franklin quote excuses the advisors from the infinite loop of trying to rescue the un-rescuable. It provides a foundation for declaring the CEO a ‘fool,’ and creates the permission framework for seeking a change in leadership. Ignoring the board’s input is a treacherous path for a CEO to follow. Some CEOs have such clear vision and conviction that in the face of ‘no’ winging by their ears, they trudge forward to seek the positive outcome they believe is ahead. In this case, they are following another Franklin quote “Well done is better than well said.”  However, if the result is not as promised, they have burned the bridge back to the board, and opened the door to the ‘I told you so’ outcome. Better to engage the board and bring them along as willing participants on the journey.

Franklin had two more quotes to guide a board of directors when dealing with a difficult CEO. The first is a corollary to the idea that fools will not take advice;  “Telling someone what not to do doesn't work as much as we hope to think.” As in parenting, if they are not listening to the advice, sometimes you have to let them make the mistakes, and hope for the least worst outcome. People will learn more from failures than they will from a lecture about what not to do, and a ‘wise’ CEO will grow from the experience.  

When all else fails, the last Franklin quote tends to come into play; “invest effort where it can compound, stop feeding attention to stubbornness.” At some point, the effort is better directed elsewhere. I have seen board members ‘check out’ when their input is being ignored. When the company is doing well, if they become passive observers it may have little effect. But, if the company is struggling, there is a fiduciary responsibility to engage and break through the stubbornness. A critical role for the chair is to ensure that board members remain engaged. If board members check out, they need to be drawn back in or replaced. Never forget that the CEO serves at the pleasure of the board, so rather than checking out, if the board finds the CEO unwilling to engage appropriately, their responsibility is to fix the problem, not ignore it.