KPI (key performance indicators) scorecards are essential in managing a company and communication with a board. KPI’s are the key metrics that capture the specific performance of each key area of the company. These vary both by industry and by company within each industry. Most companies seem to by-pass Scorecards. 

In selecting KPI’s, they should be clearly defined & quantifiable, tie directly to key drivers of your business, be moderate in number (don’t drop 100 KPI’s, 20 should work) and be assigned to specific managers. They should also be easily captured without a lot of work so that the creation of the weekly report is not a time sync. Usually, the CFO has the job of corralling the numbers. Each of the key team members should have their 3-5 KPI’s that they are responsible for in their area. They should be targeted at the efficiency, efficacy and profitability of your firm.

I generally break KPI’s into two categories: those that tied to the financial model and those tied to intangibles.

Metrics tied to your financial model are straight forward. What drives your revenue (P*Q) and what drives your cost. If you are an e-commerce company, these include traffic to your site, conversion, average basket size and such. Costs include cost by channel (total search cost divided by search revenue, total affiliate cost divided by affiliate revenue, etc), call center costs, etc. If you run a call center, these would include call volumes, average hold time, % resolution on first try, up sale %, etc.

Intangible metrics are those items that effect your brand and define your culture. These include metrics around employee satisfaction, customer satisfaction and such.

I would break out your sales pipeline analysis into a separate tool. This is a much more complex animal and not covered well in a scorecard. I gave an example of a tool we use in a separate post, Pipeline Management.

When venture capital and real estate mix, something has gone terribly askew. I am not talking about innovative companies like Zillow or Realtor.com but rather old fashion real estate ownership. One of the least understood liabilities for entrepreneurs is their long term lease. Some firms go as far as to sink significant sums into buildouts or outright RE ownership.

The problem is that no matter how you cut it, RE is an unproductive asset to a technology firm but a necessary evil. Every dollar sunk into RE is a dollar that can’t be spent on sales & marketing or R&D. Furthermore, it creates a senior lien to all equity. This gives your landlord control when liquidity gets tight.

Entrepreneurs make a variety of common errors when it comes to real estate:

1) Failure to Understand the Liability Impact: when an entrepreneur is signing a lease, he/she often focuses on the monthly lease rate. While trying to limit the term, he/she is focused on near-term survival often and the lease rate is enemy number one. So, you often see firms locking in 7 or 10 year leases to get the lower rate. For a 20,000 sq ft space, at $18/ft for 10 years, the company has just signed up for a $3.6m liability.  If the company is going to be around for years to come, why is this an issue?
— a) if you sell the company, you are stuck with it and it comes out of the purchase price
— b) if you run into trouble, the landlord is often the largest debtor and will drive the restructuring process.
If you see that you are going to be running into a potential liquidity squeeze (and you trust your investors), make certain that they put a secured, convertible note in place (subordinated usually to bank debt). This puts them ahead of the landlord and gives you leverage to negotiate hard with him/her. The alternative is bankruptcy and the secured note would take the company, leaving the landlord with nothing. Unsecured, the landlord is pari passu and will play hardball.

2) Overestimating Future Space Needs: entrepreneurs are optimists. They tie their RE estimates to their sales estimates. Since they will be doing $15m in year two and $30m in year three, they will need space for 100 people within 36 months. Guess what? Sales don’t ramp as expected ever nor does the headcount. You end up with reams of unused space that you are paying for and frantically have to sublet. As you grow, pack ’em tight and limit stand alone offices. The best insurance is to have a right of first refusal on adjacent space in year 3 or 5.

3) Building the Taj Mahal: pride goeth before a fall. Entrepreneurs sometimes feel that they need to have impressive digs to be taken seriously by perspective customers and partners. I have never seen a company get business because they had impressive office space versus their thriftier counter-part. It is usually because the CEO wants to feel more established and successful. You can always get affordable space if you hunt around. And, be modest in how you build it out.

4) Failure to Use a Good Tenant Rep: I don’t know why all firms don’t use tenant reps since the service is free (the landlord pays out of his side). Also, entrepreneurs pick firms that don’t work either with smaller firms often or don’t deal in the office space types appropriate for an early stage company. Ask your VC or other entrepreneurs who they have had success using.

5) Locking in Rates at the Peak: companies often find themselves expanding and feeling "immortal" during market highs. This is also when lease rates are at their highest. We are seeing a little of this return in the current market. When rates have risen and capacity is tight, be careful about locking in long-term leases and large space commitments. If you have to unload it later, you will get killed on the sublet as rates will drop back down.

6) Insufficient TI: make certain your deal has a strong tenant improvement component ($30+/ft). This helps with limiting your upfront buildout cost, but is also essential should you need to sublet as new tenants will demand it. If you don’t have enough, they will make you pay for it out of your own pocket.

Other random advice…make certain you have a buyout clause in your lease (usually around the 5 year mark). Negotiate down the letter of credit. While it is not cash out today, it will impact how low the bank will let you draw your capital to. Negotiate hard on the # of months for the line or the deposit. And, in general, be Spartan.

I view RE as a necessary evil in the start-up world. I don’t trust landlords further than I can throw them. They need predictability and consistency in their model because of the debt they assume to build/buy buildings. They have little appreciation for the volatility of the technology world and no appreciation for equity. When you get into trouble, very quickly, you can find yourself dealing with an unbending adversary. You need to protect yourself by being conservative in your space assumptions, Spartan in your aspirations and rational in your lease structuring. Religiously try to keep RE costs and total liabilities as low as possible.

"I love you. You love me. We’re a happy family…"
  — Barney the Dinosaur

I have found that there is a correlation between either the number of sales "war stories" or the number of sales slides in the board deck and how well the company is progressing. When things are bad, some management will spend 20 slides breaking down the pipeline a hundred different ways. The VP, Sales or the CEO also spends inordinate amounts of time describing the exciting activity at each account. Lot of activity and "really great developments" but sales seem to miraculously fall short of plan by large amounts.

My friend and former portfolio CEO, Juergen Stark, had a great name for these: Barney meetings.
He used to use this phrase to describe fruitless Business Dev meetings with partners. Everyone would talk about how excited they were to be engaged and how promising the future could be and then…nothing, nada, the big zero. Like the purple dinosaur, you could hear everyone singing "I love you. You love me…" with a great big hug at the end.

I say Death to Barney. It is bad enough when a company hits a dry spot and can’t close business. Sometimes it is because the market is not ready. Often, it is because the product has not been packaged and productized properly so it sits like a round peg in a square hole out in the market place. It is even worse if management, instead of fixing the issue, feels compelled to burn significant calories drafting a multitude of sales slides and pseudo victories. And more painful yet, the board gets to sit through this show, knowing full well what sits underneath. No one wins here. So, some thoughts around how to deep six the dinosaur.

1) Keep the war stories to a minimum in summarizing the sales situation. Discuss key events indicating positive or negative trends. Celebrate true & material wins. Point out key losses and lessons learned. Don’t go through 10 account stories of adventure and mayhem. If it is bad, don’t sugarcoat it.

2) Simplify the pipeline section. I find that one slide with names placed under closed (100%), under contract (90%), LOI/contract negotiation (75%) is all that is needed.  Show the game between this discounted total and plan. Don’t cut it by region, by channel, by sales guy, buy astrology sign, etc.

3) Give a realistic pipeline summary. Don’t toss anything in there that isn’t in contract negotiation or near final approval. I hate it when a company throws a whole bunch of 25% and 50% prospects totaling $10’s of millions and then discounts this down. Meanwhile, the 100% and 90% names total a couple hundred thousand. Guess what…the company always misses their numbers since the lower probabilities never come through when and to the degree expected.

4) If you aren’t scaling and your competition is, get an objective perspective why. Don’t get a group hug going around the wonderful war stories and offhanded comments about your competition. They are kicking your butt in the market place for a reason. If you can’t get there, hire a third party to realistically tear into it.

In short, too many executives feel they have to manage their board and keep everyone happy. So, out comes the dinosaur, a lot of smoke goes up around what is really happening and everyone leaves energized by all of the wonderful activity. Forget the last slide that shows the company at 50% of plan. Guess what…time to blow away the smoke, start cutting expenses if needed and figure out why the dogs are eating the dog food. If you ever hear yourself saying "This [setback] is really a good development for us…", stop yourself and smell the roses.

My little daughter won’t be happy but Death to Barney…

Fortune published the updated list of the wealthiest people in American history, using their networth as a % of GDP to standardize figures. Some I had never heard of and some I was surprised by. I was also amazed that at his peak, John D Rockefeller’s wealth = 1/65th total GDP…
     Name                               Net Worth       %of GDP
1. Rockefeller                          $1.4B              1/65
2. Cornelius Vanderbilt             $105m             1/87
3. John Jacob Astor                $20m               1/107
4. Stephen Girard                    $7.5m              1/150 (who???)
5. Bill Gates                           $82B                1/152
6. Andrew Carnegie                 $475m              1/166
7. Alexander Stewart               $50m                1/178 (who again..Merchant Prince?)
8. Frederick Weyerhauser        $200m             1/182
9. Jay Gould                           $77m                 1/185
10.Stephen Van Rensslelaer     $10m               1/194

I often find that many of the principles and approaches I use with my kids, work well in managing deals (I can go into more detail on a later post). A recent post from Whitney Tilson highlighted yet another area where this plays out…the fine art of complimenting/motivating employees. I would hazard a guess that the lessons below apply both at work and at home. In the article, researchers lay out recent findings that praise for effort versus praise for skill or intelligence produces dramatically more positive results.  Whitney is referring to a recent article by Po Bronson, NY Magazine,  "How Not to Talk to Your Kids"

"STOP THE PRESSES!

I know I send out a ton of emails and I suspect very few of you read them all, so every month or two, when I come across an article that is a must-read, I pull out my STOP THE PRESSES!

This article has rocked my world because the findings it outlines — for example, that while praising children is good, the key is to focus on praising EFFORT, not intelligence — have hugely powerful implications for educating children and are completely contrary to conventional wisdom.

I found these results to be particularly amazing: a mere 50-minute class with one powerful message could have such an impact?!

Click here for the "How Not to Talk to Your Kids article"

One of the greatest misperceptions in the early stage entrepreneurial world is that control revolves around maintaining greater than 51% ownership in a firm. In many term sheet negotiations, I have seen entrepreneur after entrepreneur focus intently on maintaining majority ownership. While this is key for buyouts when the company is cash flow positive, it is not the key factor with venture deals. How so???

In talking with friends who have flown commercial aircraft for the main carriers, they all comment that their job involves doing things right for about 5 minutes at take-off and 5 minutes at landing. Not much action occurs otherwise (usually) during the rest of the flight. This is similar in the venture business. The majority of change, power plays, management turnover and such occur right around financing events. The rest of the time is just build up to these main events. When a company is burning cash and runs out of cash, it doesn’t matter if investors have 5% or 55%, this is when they have significant voice in the running of the business.

New investors will generally not come into deals if existing investors are not participating (insiders know more than they do and must have issues with the company if they are boycotting a financing). New investors will often come to many of the same conclusions that existing investors have about a business model, a management team or competitive situation.  So, if there are any disagreements between an entrepreneur and his/her investors (especially if the entrepreneur refuses to acknowledge or strongly disagrees), they must be resolved before the new capital comes in. Investors may be concerned that the burn is too high and the entrepreneur, hoping success is just around the corner, has his/her foot on the gas pedal. This is why you often see RIF’s and other cost reduction efforts around financings. You also see new CEO hires occuring around financings (granted most of these are with the mutual consent of the entrepreneur and investor).

Later stage investors and buyout firms will often demand 51% ownership and board control because the firms they invest in are cash flow positive or have the ability, in short order, to become self-sufficient. Without legal control, they lose their voice at the table. However, early stage companies need to realize that ownership does not drive the leverage. Of course, they will want to hold onto as much ownership as possible for economic reasons and for when they are cash flow positive. But, they should not expect this ownership to have much impact on their relationships with investors. Mutual respect, alignment of interests and cash flow are the key drivers.

Later this week, I will do a post or two based on some emails sent to me by readers about how power plays develop within the investor syndicates themselves and how this impacts the company.

"You better cut the pizza into just 4 pieces because I couldn’t eat 8"
— old punchline

I was out at dinner tonight with a number of local CEO’s and VC’s and the topic of options during recruiting came up. The consistent theme was that employees, in comparing offers from different firms, look at the number of options versus the value of the options. So, in a comparable economic transaction, if Company A had issued twice as many shares as Company B, it could offer 10,000 options as an equivalent to Company B’s 5,000. And, many recruits would find A’s offer more attractive even though they were worth the same (assuming similar preference, market/strike price differential, etc).

My experience has been very similar. An employee will view a 1,000 option grant more favorably than 500, and 10,000 more so than 5,000. Assuming that you don’t end up with a silly number of shares outstanding, you can reach your target level by using stock splits. If your average grant is 500 and you want to hit 1,000, doing a 2-for-1 stock split will get you there. It is easiest (and more affordable) to do this during a financing when the lawyers are already redrafting capitalization numbers.

My advice to employees is to avoid the warm glow of this option trap and do the following quick math:
First, you need to collect the right info. Ask your potential firms for the following…amount of preference & debt, see if the preference is participating, number of fully diluted shares, last market price and current option strike price. To figure out the value of your stock:
1) multiple the last market price times the fully diluted share base (equity value of firm)
2) subtract out the preference and the debt from this amount (remaining "common" value)
3) if the preference is participating (investor gets back his/her preference and then participates as if they had common shares), divide your share grant by the fully diluted share amount (your "ownership" percentage). If not, then back out the preferred shares from the fully diluted number (or don’t subtract out preference in #2 above).
4) multiply your percentage times the "common" value to determine your take
5) subtract out the cost of exercising the options (strike price times # of options)
6) this resulting amount is your take at recent market.
You can run this exercise for higher values to see how you would make out at other acquisition prices. You can compare the offers on an apples-to-apples basis. It is possible that a 100 option grant is worth more than a 10,000 grant at another firm.

Entrepreneurs should remember, on the other hand, that there is a psychological hurdle in getting options above 1,000 and even more so above 10,000. Seems silly but it’s true…

I was at a business school today helping judge several business plans. As group after group presented, I saw each make the same mistake as the previous. When they tried to justify the investment from the perspective of the VC, they kept telling us that this was a 40% IRR deal or a 25% IRR as if we had magical IRR thresholds.

The reality is that the venture world is all about multiples and the IRR’s are the results. I don’t know what the original legacy behind this was, but from a practical perspective, it is driven mostly by the fact that we live in a boolean world. Some is also based upon the high net worth legacy of our business. Originally, because pension law did not permit the large institutional investors in, our business was funded by family offices, endowments and foundations. Multi-generational families, while they want high IRR’s, are really looking to double or triple their invested capital.

From a portfolio perspective, if we invest in 10 deals, 4 are tube shots, 2 we fight to get our money back on, 2-3 we get 2-5x on and the 10th deal drives the return (hopefully north of 10x). If we doubled our money in 1 year (100% IRR) but lost all our money on the next deal over 6 years, we aren’t happy (net gain is $0). We don’t care that we made 2x in 1 versus 3 years or lost all of our money over 6 years versus 4 years (this impacts IRR), because we earned 1x on the capital.

We often see complex financial models with discounted cash flows, hurdle rates and such. These are useless. I have never seen a set of financials in an early stage company that ever reflect what Darwin will allow to happen in reality. So, you start your modeling with unreliable numbers. Secondly, what is the beta for an early stage biotech deal, a semi-conductor start-up, etc? Can you assess the risk associated with a given management team? How about a new market space?

Perhaps we are too lazy to try and figure this out, but after decades of effort, the only method that seems to work in the venture world is to target 10x on each early stage deal (3-5x on later stage plays). They all look like the next Microsoft, but eventually, the portfolio of these settles down to the profile above. In the early stage world, if you target, say a 40% IRR, through assuming a number of 5x wins in a compressed period of time, you will likely be out of the business. Your 5x wins, while possibly generating high IRR’s, don’t return enough multiple to pay for the 4 tube shots and 2 break-even deals. Your winners need to deliver 10x.

So, next time you are trying to convince a VC about the merits of your firm, show them how they can make 10x capital on a realistic exit scenario (not how to get a 40% IRR).

"I look for honest, able management"
— Warren Buffett

On a daily basis, entrepreneurs ask me what we look for in a CEO. Dick Costolo suggested that doing a post on this topic would make sense (as usual, he is right).  When we have made mistakes with an investment, its demise usually falls into two buckets: 1) we mistimed or misunderstood the market or 2) we backed the wrong CEO. Figuring out whom to back is very much of a black art. Famous, big company executives are just as likely to crater a company as a rank novice. The trick is finding the entrepreneur who fits in-between these worlds and has the following characteristics baked into his/her DNA:

Resourceful: he/she should be weary of raising capital and be thoughtful about taking on any dilution. Large capital raises limits exit potentials, defocuses management and ends up usually being wasted. Our worst investments usually involve a CEO who feels that throwing  capital at a problem fixes it and then feels entitled to option spiffs to offset any dilution to them. These plays lead to 2-3x returns at best and more often in damaged capitalization structures. Like the difference between a great and poor developer, doing it efficiently/creatively versus throwing more resources at it leads to significantly better results. Would you prefer that you had one quality mechanic focusing and fixing your car or an army of grease monkeys poking around trying different things (often with a very structured methodology) and running the bill up?

Relentless: Technology is all about being the market leader (as they say, who was the second person to fly across the Atlantic?). I like CEO’s who are competitive and paranoid about the competition. CEO’s often become complacent by putting down the competition’s products while extolling the virtues of their own. I like CEO’s who are self-critical and come out and say "we are not doing xyz well and we face a significant threat from competitor A on …".  They should abhor losing bake-offs to competitors and continually push their teams hard to iterate product quickly.  In the long run, "all technology companies are dead" (Roger McNamee) as there is no market more darwinistic. Scorched earth…

Creative Thought: we appreciate entrepreneurs who look at problems differently. Successful companies do so not by doing things the same way as their competitors. It gets our attention when we learn something new or view an old problem through a new lens.

Responsive: Keeping with the "R" theme here, we want to see entrepreneurs who see either opportunities or issues and quickly iterate solutions for them. We like resourceful teams that come up with creative, simple responses. They respond quickly to developments in a measured way when needed. They out execute the other competitors.

Proactive: tells us problems or opportunities before we see them or they become self-apparent. I like entrepreneurs who are frank and to the point. I hate Barney meetings (you love me, I love you) where everything is coated in positive spin. "Losing our two major customers (or our product is five months delayed) is really a good thing for us…". In pitches, entrepreneurs should acknowledge biases or skepticism and identify actions or layout ameliorating factors.

Honest/Open Communicator: No politics, no hidden agendas. We need to build the company together. Too many times, entrepreneurs view it as them and us which leads to divisive interactions and lack of trust. Speak your mind. Don’t play the sides against the middle as this will result in his/her eventual dismissal or trip to the woodshed. Life is too short for this kind of crap.

Justified Confidence: Pride (and ego) goeth before a fall. Cocky, self-assured entrepreneurs are setting themselves up for a beating. However, great companies are willed into existence. Entrepreneurs need to communication the vision (the "North Star") and then convey a sense of inevitability. It is hard to explain, but it is an ethos of confidence and certainty. In end, they leave you believing they can do it.

Strong Domain Knowledge: people who come from an industry or technology sector tend to do better than those who are smart but moving into a new sector. They know the dynamics of the industry, its competitors, its history, its customers and has learned from past mistakes or failed efforts. Each industry has its own nuances and we would prefer that the entrepreneur have that knowledge versus learning on our nickel.

Respect for downside: I like entrepreneurs who have failed or who have a healthy appreciation for the likelihood and unpleasantness of the downside. Entrepreneurs are optimists by nature. Knowing the dark side gives them an appreciation for how critical discipline, efficiency and slight paranoia are.   

Leadership/Inspirational: they can define and evangelize their vision. people want to work for them. Enough said since this is often the lead criteria for most posts on this topic. Think big and inspire…

Two key theme we discuss often here are: the importance of simplicity and transparency with customers and beware of strategics. Well…

Microsoft recently launched the Zune player. It is a massacre. You have probably seen the (uniformly horrible) reviews. It could be one of the quickest tube shots (or bloodiest) in the history of consumer electronics. Surprisingly enough, this is the same team that successfully launched the XBox and has put Sony in its current bind. Why the issue?

There are two culprits: Microsoft is trying to be too cute and they are also dancing too close to the devil.

Respect Your Installed Base:
In order to grab exclusive control over the player and content, they have sold all of their Windows Media Player partners downstream (Rhapsody, Yahoo, etc). The Zune will not accept their music and you can’t buy Windows Media content at the store (sorry Samsung and all). So, trying to be cute and stealing a page from Apple’s book, they have ended up throwing away one of their few assets…an installed user base.

Minimalism and Common Sense:
In order to throw in all their function (like WiFi sharing), they have made a clunky, brown music player. It is much larger than the iPod and looks more like an Archos. It’s like Windows vs Mac all over again.

Make Purchase Simple and Eliminate Friction:
Microsoft has hired a few too many consumer consultants on the design of their music store. The complexity of buying music is amazing. They are getting too cute for their own good. You have to buy in $5 chunks which forces buyers to give Microsoft float. You don’t buy with dollars, but with points since consumers tend to spend more money when they redeem points versus dollars (think of your average kids fair). You also redeem 79 points for a song which is designed to make you think it is less than the $0.99 Apple songs. In other words, they try to game you at every corner. The result is a convoluted solution with lots of friction points.

In contrast, the Apple store has one click purchase, stores your credit card, charges you $0.99 and you can buy whatever quantity you want. It is so simple, I find myself buying way to many songs since I just look them up and then click buy.

Give the Devil the Heisman:
I have danced with the record labels and they will pile constraints on you until they make your business model unworkable. Strategics don’t think rationally in fast moving markets and, like a drowning man, will take you down with them often.

Many of Microsoft’s woes are driven by restrictions thrust upon them by the labels including, I am certain, much of the idiotic DRM scheme. I saw, first hand, an investment (Dataplay) bury $180m in the ground because of DRM restrictions demanded by the labels.

As one of my favorite CEO’s, Tim Stultz says "Ask for forgiveness, not permission."

I own Macs everywhere, am drowning in iPods and enjoy our XBox 360. Thank goodness for Microsoft that Apple hasn’t come into console gaming…