Thoughts on Annual Plans

Words you don't hear in venture; "Great it's annual planning time".

Words You Don't Hear in Venture; "Great it's annual planning time!" 

In the next two months, I will sit through seven annual planning board meetings. It's a grind but an important one. Once a company has revenue, "making the numbers" —"like it or not"—becomes the shorthand by which management is judged.  Scale is getting together with a number of our CFOs this week to talk about the best ways to make the annual planning process more effective. Going into that meeting, this is my list—written from a board member perspective—on what I would say to CFOs about how to get a board member to an informed "yes" to approve the annual plan.

Start with the Big Picture
Provide some context on what the company is trying to achieve in the next year. Spend time with the CEO on this. What—from a business perspective, not a purely financial perspective—is the company trying to achieve? The financial plan should map to these goals and should be judged in that context. Don't assume your board grasps the big picture; spell it out.

If the CEO and CFO cannot provide two or three clearly articulated business goals for the next year, the planning process is doomed.

Show the Assumptions
Show the key assumptions that drive the plan. For example, in an enterprise software company, sales rep productivity is almost certainly a key metric.  Show the average rep productivity metric for the past two years and spell out the improvement you are assuming in the FY14 plan. Do the same for all the key metrics.  As a board member, the question in my mind is always this, "What do I have to believe will stay the same, or get better, to believe in this plan?"   Your job is to make it easy for board members to answer this question.

Simplify the Assumptions
Keep the assumptions simple.  A good plan will include lots of detail because teams need detail to get the plan right. However, to have a meaningful conversation with the board, reduce your plan to a small number of key drivers. Boards don't like to see just the financial statements and a 10MB model. Instead, show them ten key assumptions for FY14 and, for context, provide the actual results alongside each assumption for FY12 and FY13.

Use the Company KPIs
The assumptions you lay out in the annual plan should be the same metrics that the operations/sales team uses to manage the business. That way, the team is fluent with the metrics and becomes progressively more comfortable as they use them throughout the year.  If the finance team establishes KPIs but the rest of the team doesn't use them, the budget becomes divorced from the reality of the business. The more you are aligned on metrics, the more you can push responsibility down in the organization.

Revenue Estimates
You can predict costs with precision but revenue, not so much. Instead, you have to apply judgment to the revenue calculation. Board members find it helpful to understand the thought process that led to your revenue estimate. Suggestions include showing how to bridge revenue from last year to this year, doing multiple cross checks on the revenue build up, and providing some clarity around level of "slack" inserted.  Every board member is trying to get a vision of how you will make your number.   It's your job to help them get there.

Bookings Metrics
GAAP revenue is a trailing metric. Most companies will also use a forward-looking metric such as MRR (monthly recurring revenue), bookings, ACV (average contract value), or TCV (total contract value). Pick a single metric and work really hard to ensure that it is used consistently. Nothing is more frustrating than to have a metric in finance that the sales team simply ignores. Pick one and make it stick. If sales commissions are not based on it, it is not a real metric.

Mind the GAAP Gap
We prefer startups use metrics such as MRR or ACV because these measures take "unit of time" into account. Metrics like TCV can be distorted by multiyear bookings and you end up with a "GAAP gap".  This GAAP gap occurs when great bookings traction fails to materialize as GAAP revenue.  After seeing this phenomenon many times, we've learned to monitor carefully how quickly a bookings metrics shows up as revenue.  If bookings don't lead to revenue, we know something is wrong with the model. Finance should always be checking for a GAAP gap.

Headcount
Show a headcount chart across the key functional areas with the headcount adds by quarter.  People are expensive.  If revenue is not tracking, the least painful way to slow down the cash burn is to adjust the rate of new hires.  It's important to understand what the options are to manage headcount.

Expense Categorization
Show the expenses in the SEC/Accounting major categories: COGS, Sales and Marketing, R&D, G&A. It can also be helpful to see a simple list of the expenses classified by type: i.e. total salaries, total rent, marketing programs, etc  but don't provide these expense types without also showing them in the major accounting categories.

Marketing to Sales Sanity Check
You must have some simple math to explain how deals move from the top of the funnel all the way to closed deals. Don't keep it a secret.  And, make sure that marketing and sales agree on these assumptions and use them consistently. It is stunning how often I notice a disconnect between what marketing expects and what sales requires. As a high level sanity check, compare relative growth of marketing program dollars to the total volume of new sales required.

Investment Initiatives
As a company matures, it can be helpful to think about the annual plan as a plan for several businesses under a larger umbrella.  Some are in scaling mode, typically the core go-to-market business in North America, while others are new go-to-market initiatives, almost certainly consuming net cash. If your company is making an investment in international expansion or in a channel overlay strategy, call this out separately and explain how you will measure success.

Know Your Total Cash Needs
Any annual planning process will result in one of three outcomes on cash:

  • The company is cash flow positive and does not need to raise money.
  • The company is not cash flow positive for the year but has enough cash in the bank for that year.
  • The company is not cash flow positive and needs to raise money within the year.

In all but the first scenario, you need as the CFO to have an answer to the following question, "How much does the company need to raise to reach cash flow breakeven?" It requires a multiyear plan.  The plan will not be accurate but the alternative—no plan at all—is worse. When you end your presentation saying, "We exit this year with a $15MM burn and $5MM in the bank", you leave the board hanging like a bad TV serial drama. State to the board exactly how much cash you need, in total.

Multi-Year Planning and Mid-Term Revisions
The big decision for most technology companies is how much to invest in sales and marketing.  One reason for this challenge is that there is an inherent lag between when you invest in these functions and when the business starts generating  revenue.  We've seen a fairly consistent planning bias: companies show aggressive investment early on in the year and then taper off of investment to get to cash flow breakeven. The "cost" of under investment in sales and marketing—lower revenue growth—does not show up until the following year.

One way to highlight this issue is to do a multiyear projection as discussed above. Another way is to decide to have a mid-year check-in. If the company is tracking well, you can decide to green light more investment.  If you are face challenges or if capital is scarce, you stick with the original plan.

Board Presentation
Aim to be succinct.  It should take you only 5 to 10 slides, max, to lay out the assumptions, do the revenue build up, and show the headcounts adds.  After that point, you lose everyone's attention.  Once you've gone over these topics, show the basic financials by quarter for the planning period and perhaps a multi-year profit and loss statement covering both historical numbers and one to three years of projections. Everything else can go in the Appendix.

Backup Information
The list of items people could ask to see or might find useful is long. This is why some annual plan presentations take forever. Here is a partial list of information that gets requested:

  • Sensitivity analysis.  It is often helpful to see how variations in some of the key assumptions affect the outcome, especially if you assume some significant improvement.  I find the best way to look at multiple scenarios is to prepare waterfall charts showing how each scenario affects the key numbers (bookings, revenue, cash etc).
  • Benchmarking data.   Compare your assumptions to other successful companies in your sector. To state the obvious, if your plan assumes faster growth than the most successful company in your market, you need to rethink that plan
  • Build a complete book.  When the final budget is approved, with all the final changes, prepare a final version of the plan.  Don't just update just the summary statements; provide an updated copy of all of the backup documentation.  Save it as excel or even a PDF/hardcopy and send it to all your board members. Board members find it very helpful to have the one version of truth on file that they can always go back to—without bugging the CFO.
  • A reconciliation from the non GAAP to the GAAP P&L As a company gets closer to an IPO, finance has to prepare full GAAP financials including stock based compensation, amortization of intangibles, etc. However, statements in this format of statements are probably not as useful for decision making.  Thus, a typical backup analysis that you should do is a reconciliation from the non-GAAP to GAAP financials. GAAP financials are much more useful than trying to make decisions from financials that include significant amortization of intangibles.

I m not saying that if you follow these steps, the annual plan review process will be painless.  By taking this advice to heart, however, you will be more prepared for the questions you will receive and, likely, more confident in your delivery.