This spring and early summer, I had the opportunity to attend my first start-up conferences (TechChill in #Latvia & Latitude59 in #Estonia) and talked with some founders about the value of financial planning and budgeting activities.
Surprisingly, most founders mentioned that these activities would not be one of their priorities or that they felt the financial plan already created as a part of their initial business plan would suffice to steer the company.
We also constantly hear that entrepreneurs tend to avoid creating some formal structures and processes as they can view these as bureaucratic threats endangering creativity and speed.
There are many experienced entrepreneurs or venture capitalists like Verne Harnish (scale up expert & author) or Ben Horowitz, who share their experiences about the “black art” of scaling (you can find a summary at the end of this post). However, I would like to draw your attention to a case study performed by Ranjay Gulati and Alicia DeSantola published in the Harvard Business Review ("Start-Ups That Last: How to scale your business", March 2016).
What did they find out?
Hiring functional experts
As a business rapidly grows, so does its operational complexity. Founders and early employees need to realise that a “jack of all trades, master of none” philosophy is suited for a start-up but not a scale-up and they do not possess the required skill sets to perform all activities that arise at the highest level of quality (we can't know everything…).
Functional experts will perform these activities more efficiently and “implement best practices within their domains” while the core team members will be able to put their strengths back into action.
Scalable infrastructure
Have you heard of Mikitani, founder and CEO of the Japanese electronic commerce and online retailing company Rakuten, and his “Rule of 3 and 10”?
Every time a company triples in size, "everything breaks" (“The cofounder of Evernote shares the best advice he's ever received as a CEO”, Business Insider, 2015).
This includes “how the company handles payroll, how managers schedule meetings, how teams communicate, how it budgets, and how its hierarchy is balanced”.
Adding a balanced level of management structures and processes linked with empowerment will actually enforce “information flow, decision making & execution”.
Ben Horowitz (The Hard Thing About Hard Things (p. 190-191). Harper Business. Kindle Edition) describes the purpose of processes as a form of communication. “Ad-hoc, point-to-point communication no longer works” when your company grows from 5 employees to hundreds and your communication channels will have to be adjusted. A “process is a formal, well-structured communication vehicle” and ensures information flow.
Meanwhile a centralised authority, like founders, who want all decisions passed through them actually hinder decision making & execution. These founders end up not being able to manage different types of specialised daily tasks while employees become frustrated struggling for access to decision makers and a lack of progress.
Planning & Forecast with discipline
Innovation, creativity and improvisation is the backbone of each start-up. However, constant improvisation without any data or an eye toward larger goals essentially amounts to “aimless riffing”.
Gulati & DeSantola describe how planning gaps at operational and tactical levels (e.g. no data on lead times, limited sales data from distribution channel partner) lead to bad inventory management and thus significant cash flow challenges and a limited ability to launch new products.
This is why data analytics and a framework of plans & goals for guidance are important during growth phases.
Cultural values
Start-ups need to be creative to attract top talent as they do not have the same cash resources as large companies to present a financially attractive offer. This is why they tend to motivate their employees with non-cash benefits such as shares and… an attractive company culture.
However, keeping the same company culture and camaraderie will become more difficult as your workforce grows.
Gulati & DeSantola found out that only a few founders take the steps to reinforce company culture because too many shift their focus “to things that feel more urgent, such as operations and marketing”.
Financial planning & incentive-based compensation strategy as a support tool
Now that we have identified the critical success factors to successfully scale and build an important company, I would like to explain how financial planning & budgeting activities as well as an incentive-based compensation strategy can help you to achieve these success factors:
A financial plan and budgeting process should reflect your up-to-date organisational management structure. Team budgets and/or goals built on the basis of an operational plan will clearly define roles and responsibilities, which is particularly important when implementing the new organisational structure. Defining your bottom-up financial & operational plan will also help you to understand how many management layers are necessary.
A formal annual process to build your next operational & financial plan will help you to
rethink your critical activities and implement an action plan (remember the “rule of 3 and 10”),
ensure qualitative communication and a flow of information (both bottom-up and top-down), and
empower your employees in their day-to-day activities (no need to get the OK for every decision if it was already “stamped” by your executive team).
The process and common discussions to develop a consolidated plan ensures that all executives and teams are well aligned (remember how missing alignment between sales and operations can lead to bad inventory management and avoidable extra costs)
Building a plan, paired with Risk & Opportunity management and sensitivity analyses, will actually foster not only quick but also smart decision making when problems arise. Yes, building a plan takes time in the beginning but will save time in critical situations when you need to act quickly and decisively.
Annual plans define the path on how to achieve your long-term goals and vision. They also ensure you stay on course in chaotic phases.
Use your compensation strategy to spell out and reinforce your cultural values. How?
If you wish to reinforce team-work, build a bonus system based on your team- instead of individual targets and bonuses.
Do you have a problem with quality? Use KPIs such as customer satisfaction or the level of manufacturing waste.
Add a goal from your CSR strategy to your bonus system, such as employee engagement, health or sustainability.
The overall key success factor for a scale-up is to find the right balance between agility & adaptability and discipline to stay on course on what really matters:
What do you think? Leave your comments in the comment section!
You can also go to my website to book a free session to discuss how Zegners FinPlan can help your company.
P.S. The next blog post will be about the different types of investors and the different approaches to how they support their portfolio companies. Stay tuned!
Backup
As promised, here's an overview of the critical success factors created by Ranjay Gulati and Alicia DeSantola, scaleup expert Verne Harnish, VC & Entrepreneur Ben Horowitz and management consulting company Moniquet & Company:
Ranjay Gulati and Alicia DeSantola
“Start-Ups That Last” published in the Harvard Business Review (March 2016)
Firms must hire functional experts to take the enterprise to the next level,
add management structures to accommodate increased headcount while maintaining informal ties across the organization,
build planning and forecasting capabilities, and
spell out and reinforce the cultural values that will sustain the business.
Scaleup expert Verne Harnish
(also world-renowned speaker & bestselling author of “Scaling Up: How a Few Companies Make It...and Why the Rest Don't”)
Verne Harnish listed his “Top 10 Reasons Startups Fail After Their First Growth Spurt”:
Scaling up too fast / prematurely
Lack of focus and alignment
Hiring prematurely
Mistaking leadership for management
Not setting long-term goals
Saying yes to every customer request (“over-customizing”)
Focusing on marketing too little or too late
Postponing the next-round funding too long
Lacking a scalable infrastructure
Not being agile
Link: https://blog.growthinstitute.com/scale-up-blueprint/10-mistakes-startups-make-under-rapid-growth
VC & Entrepreneur Ben Horowitz
(co-founder of Andreessen Horowitz and one of Silicon Valley's most respected and experienced entrepreneurs)
The “black art” of scaling a human organization includes:
Specialisation
Organisational design as the communications architecture for your company
Process with the purpose of communication (and it's easier to add people to old processes than new processes to old people)
Source: Horowitz, Ben. The Hard Thing About Hard Things (p. 188). Harper Business. Kindle Edition.
Management Consulting company Moniquet & Company
The challenges of fast-growing organizations (translated from Dutch)
Strategy over (standardised) structure
Growth over profit maximisation
Recruitment and Development
Organizational skills and culture
Cash flow and efficiency