Published by the Canadian Venture Capital Association in Private Capital
If early stage companies know little about the expectations of venture capitalists (see Bridging the Gap, Spring 2011 edition of Private Capital), they probably know even less about the working relationship between the two parties post-investment. While VC’s might see the next steps as obvious (“let’s go and build a great company!”), early stage companies may be exhausted and overwhelmed from the due diligence and closing process and may simply be wishing for things to return to normal; but will their world ever be “normal” again? Most VC’s certainly hope not.
If the devil is in the details, the challenge is in the goal: taking a largely unproven, early stage business and building it into a great company. To a VC, this means the elusive “big win”; the company that grows from mere obscurity to sales of $50 million, $75 million, or more. Beyond the cash that is generated, these winning companies are leaders in their markets, innovators in their industry, and perhaps, most importantly, they share in this powerful vision of top tier growth. They too want to build a great company, and will take whatever assistance and valuable insight they can find in order to get there.
If a journey begins with a single step, where do you start? Surprisingly, there may not be a lot of magic in terms of starting the relationship with a new portfolio company off on the right path. As with the preparation for raising early stage capital, the fundamentals also matter when building a business. Although strategy is important, what can be even more critical is successful implementation (i.e., getting it done!), while being in tune with the industry and market to know when to shift gears and make the necessary changes.
Investee companies need to take the necessary steps to build the business to support future growth, and not get caught up in the status quo. And while distractions often arise, it is critical to focus on the fundamentals and the ultimate goal, a discipline that can be difficult for young companies.
As part of this process, a number of key areas require careful and consistent attention, including:
|Fundamental Area||Critical Success Factors|
|Aligned Objectives||Management buy-in to the short term and long term objectives, as well as the exit strategy. Willingness to use experienced resources/advice to grow the company. Consistent focus on what is in the best interest of the business|
|Product||Focus on sustainable competitive advantage. Strong understanding of industry and market developments to guide future product development efforts. Ability to deliver new products and product enhancements on a timely basis|
|Market||Demonstrated ability to reach and penetrate target market(s) through an appropriate strategy (i.e., pricing, advertising, promotion, distribution, etc.). Strong focus on competitive landscape and market developments, making necessary adjustments to grow market position|
|Management||Management team includes those with aligned objectives, the right skills and expertise, and strong implementation skills. Problem areas are addressed on a timely basis|
|Financial Results & Capital Requirements||Timely and accurate financial information that is used to track progress and make adjustments where needed. Established short term budgets and long term financial targets, as well as the necessary capital to achieve results|
|Exit Strategy||Well developed strategy, including estimated timeline, key milestones, and exit approach. Should consider market and industry trends and outlook|
Given the importance of building the business to support future growth, management may lack the experience to do so, but can gain valuable assistance from the expertise that VC’s bring to the table. In order to raise the likelihood of success: (i) management needs to be receptive of this type of assistance; and (ii) VC’s need to take an active role in providing it. Although it is a given that VC’s don’t run companies, this process can mean that early stage investors might have to roll up their sleeves more than they would like, particularly when difficulties arise. Failing to do so could result in a company that never really reaches its potential, falling well short of “great”.
Beyond providing assistance with the fundamentals, important problem areas for VC’s to play an active role in resolving include the following types of situations:
When the founder flounders Just because a CEO has what it takes to start a business and manage it in the early days does not mean that they have the skillset and desire to build a company. It’s been said that many high growth companies have at least three CEO’s during the course of their history: one to start the business, one to grow the business, and one to position the company for exit. All of these situations have a different focus and require different skillsets. Chances are that all of these skillsets do not reside within a single CEO, so a change in leadership as part of the strategy should not be surprising. It can, in fact, represent an opportunity to drive growth in each stage of development.
Where the issue can become really problematic, however, is with a CEO who is truly out of their element. This situation can be typical with early stage companies, where: (i) one of the founders was arbitrarily put in the CEO position, but clearly lacks the necessary skillset; or (ii) the investee company hired the best CEO they could afford, on a very limited or part time budget, and got what they paid for.
In any event, VC’s need to recognize situations where the “CEO has to go” and take swift action. Weaknesses at the top normally don’t turn around, and sub-par performance results in opportunity that is forever lost. Although CEO recruitment is often a time consuming process, leadership is beyond important and maintaining a poor CEO and hoping for improvement does not represent a strategy for resolving the problem or for generating solid financial results.
When financial management gets no respect Many young companies underestimate the importance of the finance function, including the critical nature of timely financial information as a management tool, as well as in terms of attracting capital. Companies with a significant technical or intellectual property component, in particular, tend to put the majority of their resources into technology or product related areas, while downplaying the need to hire a qualified Controller or CFO.
It is often up to the VC to drive change in this area, as they truly recognize just how much a good CFO can do for a company, especially when there is more capital to raise. VC’s need to ensure that companies build a finance function that can support future growth and create the necessary level of confidence to attract future investors. The bottom line is that sound financial management is always critical, and you simply won’t build a great company without the right resources and systems in the finance function.
When the culture isn’t a learning one Building an early stage business can be an isolating process and the founders and their team can become overly focused on internal activities. Growing a business requires a more balanced approach, with sufficient focus being paid to customers, competitors, and market developments, as well as to internal matters. CEO’s who tend to rest on their laurels and what they already know, without upping the knowledge ante, can be a problem, as well as a sure fire way to get stuck in the status quo. Successful businesses are always learning, from the CEO’s office throughout the ranks, and building for growth requires new knowledge and skills.
VC’s can be an important catalyst in this regard, setting expectations for CEO’s to actively network and stress the importance of continuous learning throughout the company, as well as seeking out collaborative relationships, perhaps with other investees. VC’s have almost constant access to industry events and professional development opportunities crossing their desk, and taking a moment to invite portfolio companies along can help to set these important expectations and fuel growth.
When the company needs more help than a VC can provide Early stage companies often lack the experience to address issues that arise, while maintaining forward motion. This is often the case in “business as usual” situations, so imagine how much of a skill and knowledge shortfall could occur when building a company to support significant growth. Assisting an investee company in this area could become a full time job for a VC, and that’s just not workable for the long term, given that there is an entire portfolio to manage.
Hands on advisors can be a real help in this type of situation, and VC’s should play an active role in making it happen. Early stage companies may lack the experience to fully understand the type of resources they need to assist with a particular situation, and as a result, are often not well equipped to identify the type of assistance they require. VC’s, on the other hand, have typically seen the same situations many times, understand what is needed to support growth, and can be in the best position to diagnose the problem and suggest a handful of qualified advisors who can help; they just need to make the effort to do so.
Helping portfolio companies go from good to great is not just about the big moments; it’s also about paying careful attention to the fundamentals and taking timely corrective action when needed. Setting expectations of disciplined implementation, seeking out the right resources for assistance when needed, and not tolerating sub-par performance can help to make the most of investment opportunities. It could be the difference between a breakout company and those that just plod along.