One of the most obvious observations I make with growing company CEO’s is that planning for a new office is done with an optimistic view of the future, incorporating planned space that compromises only slightly the measured needs for the next three or more years as outlined in the financial forecast. Yes, we can mitigate that with starting with a reduced size given the current remote and hybrid work environment.

But… Do we still plan for growth in our infrastructure?

Signing a lease for space enough to handle the growth called for in the business plan, is a predictable group behavior I’ve come to label “The tyranny of the new office.”  The company plans a move to a new facility with plenty of space that is probably built out but not planned for use until the company grows to the next stage of need.  Office employees expected to work in the office regularly move into their new cubicles and offices, spread out far more than in the previous facility.  The excitement and noise of working in too close proximity to cohorts suddenly becomes an unexpected near silence, as everyone notices that they do not have to raise their voices any more to be heard above the din of noise.

And the result of this empty space before the growth spurt?

[Email readers, continue here…]    The exciting sounds of an office filled to capacity functioning in a growth environment are exhilarating to most that have experienced it. The distractions are dealt with using earphones with their smartphones, concentration and tolerance; but they are dealt with by all.  The change to a near silent environment is so startling that, many times, employees express a bit of resentment or even depression, masked by the common statement that “it is so much easier to get work done without the noise.”  It is the excitement of activity that generates more and better output for most, not the isolation of silence.

But back to “the tyranny of the new office.”

Two predictable outcomes almost always follow a move into an office much larger than today’s needs. First, you’ll find subtle moves by employees into the unused, reserved space.  After all, it is there and unneeded for now.  Why not make use of the space until needed?

And second, management sees the open space and often finds it easier to justify acceleration of one or more new hires since the facility is available and infrastructure complete.  Unconsciously longing for a bit more of the excitement from the noise of the previous office, managers often make subtle unrecognized moves to fill the void with new hires earlier than planned.  That’s why the label, “tyranny” even if the word seems out of context.

If and when asked, I always recommend more frequent moves as opposed to longer-term leases.  It seems from experience that both the company and the employees gain from such staggered moves.

Next week: It is time to examine the CEO’s relationships with con-temporaries, coaches, good board members and great resources in the community and industry.

It is statistically true that at least half of the young companies funded by angel or venture investors will not survive three years from funding to demise, and more than that percentage will die with two years if not well financed.  The greatest burden of either a growing company or one needing to retract and reduce expenses is the office lease – especially in these years after COVID and remote work.  Although payroll is almost always the greatest cost, companies have flexibility as to how to handle both rapid growth and rapid decline in the personnel arena.

Rapid growth?  Home workers? Business contraction?

The most difficult thing to deal with in any of these events – now or future – is the office lease.  A five-year lease may be cheaper per month than a three-year lease and may provide for more free rent and tenant improvements.  Those benefits pale in comparison to the high cost of retaining or buying out a longer-term lease when growing or reducing in size or misjudging number of at-the-office employees – which is most of the time for early-stage companies.

What is flexibility worth in higher cost?

[Email readers, continue here…]   From personal experience with many companies in my portfolio and from many board experiences over the years, young companies are unpredictably unstable in their facilities requirements. Flexibility is worth a few percentage points of fixed cost when companies are in high growth mode or are at early stages of proof of market.

Yes, it’s a hassle to move offices.

It is a hassle to move, requiring time and planning.  It is much worse to worry overpaying for two leases each month and tying up two large deposits.  Or honoring a personal guarantee if the company cannot pay.

Then there is the dread of “The tyranny of the new office” to worry about. But that is a story for next week’s insight…

Several years ago and before COVID’s changes, I became involved with a Southeast Asian company looking to expand into the United States.  During the discussions with the CEO about hiring North American managers, he made it clear that he wanted us to find a first-class office facility from which to start the search process, and proceeded to name cities that attracted him.  Even after discouraging him from this backwards method of infrastructure-building, he kept bringing up the subject in subsequent months as new senior managers and salespeople were hired, each starting with an orientation week at the Asian headquarters then returning to work from home.

Everything has changed of course.

With audio and video conferencing and all the tools for communication and collaboration available today, each of these four new employees felt empowered, connected and enthused to work from home for the first time.  The CEO was still talking about finding an office when the natural progression of growth made it obvious that two of the four needed to be replaced.  These two worked from homes in widely scattered cities.  Had the office been located to accommodate either one, the company would have had to find replacements in the same geographical area as the office.  Without that restriction, outstanding replacements could be located based upon skill and experience, not location.

We know that the best employees may elect home, hybrid, or walking out.

Most businesses, especially start-ups, benefit from the establishment of a virtual environment. The flexibility in hiring decisions, reduced fixed costs, forced highly specific communications and better definition of job responsibilities that most often result from need, almost always give a virtual company the edge financially and flexibly.

Would you renew your existing office lease today?

[ Email readers, continue here…]   More mature companies are saddled with sometimes expensive facilities, often poorly used by a minority of employees.  Five-year leases that seemed a bargain before COVID are most often albatrosses today.

And when does senior management show the flag at the office?  Most want the same flexibility as those they manage.  So, one of the advantages of new or young employees – having visibility and time with their managers – cannot easily be realized, frustrating the employee who made the extra effort to come into the office.

The bottom line for most companies is that the need may still be there, but the size of the space can be drastically reduced and should be.  Landlords know this, and at renewal time are more flexible now, willing to divide spaces to retain tenants with the negotiation power shifting from landlord to tenant.

Yes, every company is different.

During COVID, we sometimes called these “must be in the office” or on-the-floor employees “essential.”  The extra burden of travel cost and time was theirs to bear without extra compensation compared to their peers.  Which leads to the question: “Would you pay more for those who you insist on or who must come to the place of work?  These are complex questions, but when couched in this way – in terms of higher employee cost as well as higher infrastructure cost, become easier for management.  You must decide between hybrid, virtual or forced in-the-office balancing economics with productivity and ability to retain and attract the best employees.

The world has changed, and you must not just “remember how it used to be.”

So, can a company of any size exist for a reasonably long time as a virtual company? 

As recently as 2019, there was a stigma that prevented many CEO’s from thinking it possible.  Today, virtual offices are accepted at all levels of many organizations of all sizes.

Just ignore the signs for long enough and the job is done.  It takes far more energy to regularly review the key performance indicators you’ve established for each individual and yourself.  But a small excursion caught early and corrected saves massive corrective resources later.

Here’s an example:

Take for example the manufacturing company with a small quality problem in one component, resulting in a test failure rate above the norm.  You can just reject the components, especially if coming from an outside supplier, or you can get to the root of the problem by examining the cause and reengineering the process or product quickly, saving you and perhaps your supplier time and cost.  Such a culture of quality engineering has an additional benefit in creating a higher bar for all to see, making the public statement that quality is a top priority.

Is this just your problem?

[Email readers, continue here…]   The same careful management applies to virtually every person and process in the organization.  If there are ways to measure successful output or execution, find them and use them regularly.

If one person or department is not pulling its weight, others notice and if no action is taken, often others are discouraged because of the lack of management interest and control.  The variant of “one bad apple” holds true in corporate cultures that to a degree entrepreneurial managers and young CEOs rarely credit – until a late correction is made and a collective sigh of relief can be heard company-wide.

Obviously, we all want to sell at the top.  And there is the problem.  How do you know when you are at or near that right point to sell for maximum value?  Those of us in the business of calculating (guessing) this mythical peak in value often make the same mistake as our entrepreneurs.  We hang on just a little bit longer, expecting continued or accelerating growth and value as in previous periods of the same.

But there are wolves in the woods.

Yes, there are – when it comes to entrepreneurial growth.  Companies sometime run out of cash in the midst of their increasing success, and often find that sources of loans or investment are not freely flowing at the moment of need.

Growth brings financial issues.

Young companies have been known to outgrow the abilities of management to focus and direct them, failing to make the transition to organized, stable growth.  Competitors, seeing a successful development of a niche, flock into the competitive void with products or services built with a fresh view of the current environment.

[Email readers, continue here…]   Think of major companies, public and private, that have lost their shiny appeal over time, including Zinga, LivingSocial and Fisker in this generation – and Alta Vista in the last.

So, the question: load up with more equity and dilution? Or sell now?

For young companies, often the question is whether to suffer a new round of dilution to stimulate growth, or to sell earlier and not share the (presumably) increased proceeds with additional investors.  Not so long ago, Basil Peters wrote his book, “Early Exits,” after analyzing 150 young companies and their exits.  He concluded that the sweet spot for valuation was in the $20–30 million sales price range, and that many, many times more deals were completed in that range than above $100 million in valuation at exit.  Adjusting these numbers to fit your circumstance, the conclusion is that waiting for higher value after sustained growth becomes more and more of a risk in the majority of early stage cases.

What about those unicorns?

There are only a few Uber or AirBnB investments to point to – where the street value of the company may ultimately validate that amount of investment.  LivingSocial took in $583 million in capital in 2010 and 2011 with little left in time to show for the investment and tremendous dilution to the founders.

And some of us know from experience that, in a retrospective view, some of our entrepreneurs and their boards of directors pay the ultimate price of erasing all economic value by waiting too long.  In such instances, the phrase, “race to zero,” perfectly describes the result of a miscalculation in the name of either optimism or greed.

It is no secret that the IRS carefully looks below the surface for personal use of company assets (including cash) in its corporate income tax audits.  This insight addresses more the impact of such behavior upon the actions of employees and others who observe that behavior from a senior manager or owner of a business – and know that they cannot say anything about it without jeopardizing their jobs.

Is this just an earned perk?

Use of a corporation as a personal piggy bank seems to be an earned perk in the mind of some entrepreneurs and some CEOs, reasoning that the only harm in doing so is in taxes never paid to the IRS.  The truth is that there is a much deeper degree of damage done to the moral and ethical fiber of the company itself, and certainly to the credibility of the executive or entrepreneur with employees.

Addressing company culture with negative actions

[Email readers, continue here…]     The culture of a company is created from the sum of many parts, most all coming from the top.  One of the most toxic shocks to good culture comes when a promise of ethical decency and mutually fair behavior is breached by a senior manager, observed by others.   Think of the effect of locking the supply cabinet only to take from it whatever the person controlling the security of the cabinet wishes for personal use.  Or of the reaction of your accounting person when asked to book obvious personal uses of the corporate credit card as company expense.  Or flaunting the privilege of that corporate card by charging expensive meals with high priced wines when not entertaining outside guests.

The most damaging effect of all…

And there is another degree of damage to measure in more extreme cases – the robbing of the entity’s ability to finance its own growth, sometimes causing reliance upon bank loans or other sources of capital.

Those in charge, even if one hundred percent owners of the business, have a special obligation to be open, lawful, and ethical in the use of those assets upon which others depend for their continued jobs and living wage.

The surprising recurring revenue trap

There is a phenomenon I have observed time after time with mature companies receiving over 75% of their revenues from recurring sources.  Management undertakes a simple exercise of calculating the increased profitability of shutting down all R&D, sales and subordinate operations, and universally notes with shock the high net profit that results – from shutting down all operations except customer service to recurring customers (as in software support operations.)

Legacy system recurring revenues

Depending upon the type of business, customers are loyal often because they are creatures of habit, enjoying the existing relationship and service, not wanting to disrupt a working resource.  In fact, I am involved with one such company whose customer base extends back to the 1980’s when first purchasing their systems, still paying a regular quarterly maintenance fee to a company that services them well but has no remaining sales staff or R&D functions. The customers are happy and the company profitable.  What’s not to like?

The result of “profit only” thinking

[Email readers, continue here…]     Well, there are two problems here. The company dooms itself to a slow death over the passage of time as customers desert to newer products.  So, the decision to “go into maintenance mode” is known as “milking the cash cow” for a reason.  And second, there is no excitement in such a company to retain employees looking for advancement.  Employees who leave are replaced with people who are likely not “A” players, often causing future levels of customer service to decline.

The enterprise value of recurring revenue-based companies

And yet, there are many companies where the cost of product renewal and R&D are just too high to keep up with competition.  Companies in this predicament often can be sold for their recurring revenue stream, but the multiples they command are not high.  In such a case, milking the cash cow may well be the best decision for management rather than selling the company.

An exception: SaaS companies

We started this conversation looking at legacy companies with recurring revenue.  Companies that have built their revenue streams upon software, hardware, or other products delivered as a cloud service are a more recent phenomenon – saving capital outlays for their customers and delivering services more inexpensively using cloud-based systems.  These companies have the same R&D issues and cash cow tendencies as legacy businesses, but there are two exceptions:  new sales fall right to the bottom line in most cases, making these businesses more profitable than most capital expenditure propositions – attracting more customers without the need for financing or large up-front costs.  And the enterprise value of these businesses at the M&A or IPO stage is almost always much higher than other types of businesses because of this.

The conclusion:

Recurring revenues are oil for companies growing, reinvesting in R&D and expanded sales efforts. Those same revenues are glue to those choosing the alternative route of milking the cash cow.  In those cases, they are attractive slow, sticky streams of glue, slowing a company until it ultimately dies of old age.

The emotions we feel when “turning out the lights.”

Several times in my investing life, as the final board member making the arrangements to dispose of remaining assets, I have literally been the one to turn out the lights, carry out the documents, books and records to my car, and become the only remaining contact between the failed business and the investors, bankruptcy court, or creditors.  I volunteered to do this several times when there was no-one else, even the founders, to do this.  And these were emotional experiences to say the least.

We ask ourselves “what if?”

In aviation circles, we read in our pilot magazines about “Never again!” or “I learned about flying from that.”  Pilot-authors tell their stories in the first person, and all of us readers slow down to think while reading of these events, wondering “what if” or whether this could happen to me.  And if it did, would I have reacted differently?  Most importantly, we think: ‘Now that I know this, would I behave differently if it did happen to me?’

How about the entrepreneur -founder?

Professional investors rarely attach a red letter upon a failed entrepreneur.  In fact, if that person can tell their story and relate the lessons learned clearly, there is a positive response many of us will make to the next pitch from that person.

Investor pattern match

[Email readers, continue here…]  We who invest look for patterns from previous experience.  Some of those patterns help us to spot and avoid problems we have seen play out in the past, often to disastrous conclusion.  We learn to worry over obsolete inventory, too rapid hiring, failure to spot industry trends that make an offering less attractive, and so much more.  Most of us can tell specific stories of losses that led to these expensive and gut-wrenching lessons.

Here’s a near miss that just happened.

I just helped an entrepreneur to consider reorganizing his young business from being a value-added reseller into a software and consulting company.  It would not be handling the expensive hardware that is part of its required sale at all, other than to recommend alternatives and charge for coordinating the purchases of differing supplier products, oversee the installation. It could then charge for setting up, integrating, and training the company’s software, all because its customers would not know how to do any of these important tasks.

This follows from my previous insight: “Where there’s mystery, there’s margin.”

Asa result, the entrepreneur could avoid a fundraising effort, reduce working capital, make friends with the salespersons of multiple companies that could supply leads and references, and become instantly profitable.

Some fatal elements that might become only a near miss.

So, what if that startup could not have raised funds? What if it had a hiccup in collection of payment from a large hardware order?  What if the hardware manufacturer had serious problems with product quality on site?  All these things which could have driven the company out of business when betting very large amounts on other companies’ hardware would be avoided.

Why do we tell this story?

Turning out the lights from a company following an existing business plan to extinction teaches us lessons.  Pre-thinking alternatives to the events causing the negative exit might just prevent it.  Which would you rather do?

How about co-strategist?

I recently coached a CFO in a small company to urge the CEO to stop working upon the operational issues and focus upon the future, even if that meant a pivot to protect the business as the world was changing in that industry at an accelerated rate.  That challenge would require vision from the CEO supported by data and what-if analysis by the CFO.  How much more valuable would the role be if not to think and work strategically?

Defining the expected and common role of a true CFO

There is a simple way to define the common responsibilities of the chief financial officer.  And it extends beyond the usual interpretation of the CFO position in many companies.  If it can be counted, the CFO owns the responsibility for controlling it.  The CFO should question and control the number of anything, including the number of chairs to be ordered.  That may seem extreme to many a founder or CEO, but it serves a purpose.   It is the ultimate control over rampant spending or uncoordinated purchasing.

Where else would there be a knight-protector in a company?

Looking at it in that light, there is a check and balance for all departments and individuals ordering materials of any size that affect the cash position and profitability of the company.  Further, the CFO should speak up in executive meetings and when invited into board meetings, making sure that any major issues are vetted by the group.

Another of my stories, this time about a CFO in name only

[Email readers, continue here…]  I was an early board member of a company that subsequently raised over $30 million in venture money following the angel rounds which I led, which themselves amounted to $6 million.  I remained on the board through the life of the corporation, a witness to some surprises along the way that were, at the least, instructional.

Board member orders a ramp in spending that kills the company.

First, the VC’s ordered that the company ramp its burn rate (monthly losses in cash) to over $800,000 a month, which I could not fathom.  But even though I objected, it was their money, and they must know what they were doing, I thought, as I watched what I thought to be all-or-nothing spending.  For me this was nuts.  But the CFO dutifully followed the VC command to spend and managed the spending process well – even if it exceeded reasonable standards of control over the ever-increasing inventory, headcount, and fixed expenses as the infrastructure grew.

How the CFO could have saved the company.

But the CFO let the spending rate continue to increase out of balance with the board-approved budget which projected revenues to ramp, reducing the monthly cash burn.  In one four- hour board meeting with all board members in attendance, the board spent almost an hour with the CFO analyzing the financial performance of the company.  No talk of strategy.  No input from the CFO except to answer questions.

… and how the CFO missed the chance to be responsible.

We members of the board never saw, (never asked) and the CFO never mentioned the balance sheet and cash position.  It was eight months after the latest $11 million round and no-one thought it worth focusing on cash, since the position should have been over $5 million in cash and starting to grow – if on plan.

Then the bomb dropped…

A week after the board meeting, the CFO emailed the board that the company was only weeks from having no cash in the bank.  Can you guess the board’s reaction?  The CFO was immediately fired.  I performed a forensic audit on behalf of the board to determine if there had been any fraud or theft; but there had been none. Spending had continued out of control, much of it for inventory and assets – neither of which appear on the income statement. So those expenditures were not reviewed by the board which had not been given a balance sheet to examine.

The moral is simple. 

A CFO is responsible for all phases of cash deployment and preservation.  Failure to manage to plan, and failure to inform the board of dangerous excursions, caused this company to fail as the VC’s decided ultimately not to continue to pour money into the investment.

Maybe the CFO could not have saved this company; but he surely could have slowed the flow of cash, informing the board, and giving the board and CEO the opportunity to pivot the plan, to reduce inventory, to reduce spending, or to consider looking for a strategic partner or buyer.

Especially in companies where the CEO or founder is not a financial expert, the CFO is expected to be knowledgeable, willing to confront as well as inform, and to find early warning metrics that help in the process of effective cash management.  That person is not a bookkeeper, counting the past, but an expert at forecasting and control.  And how about that role we touched upon – as co-strategist?

What happens to careful planning?

So why do so many business authors stress this behavior? Ready, FIRE, aim. What happens to careful planning, sure-fire metrics, quality test scenarios, market research, a good business plan – all in place before pulling the trigger of a new opportunity.

And who is right here?

If you’re seeking investment from anyone other than friends and family, you’re probably going to have to navigate through the exercise of careful planning, documentation and execution.  Investors are a fickle bunch.  They want to know that their money is not just being thrown at an idea that will become a trial by “fire.”

But speed and iterations are attractive benefits

[Email readers, continue here…]   On the other side of the argument is the truth of the claim that numerous iterations in the form of rapid prototypes and execution of new ideas in the field quickly refine the product or service to meet the needs of the customer, and at a far faster and cheaper pace than with careful pre-planning.

Cowboy coding in software and Internet development

In the software and Internet arenas, there is a term for this: “cowboy coding.” Without the need to carefully document the architecture and elements of a proposed application, a single programmer can much more quickly just code, test, and create revised code.  And today, “no code” or “low code” applications can be created much more quickly without careful testing of the integration with cowboy-coded portions of an application.

Either way, without even pausing to document the process internally, no-one can easily take over the job, if for any reason the cowboy coder is no longer in control.  And the result? Typically, we call that “spaghetti code” to signify code that is so often changed that it no longer looks clean and traceable.

Our conclusion to this dilemma

The conclusion is that the best process depends upon the product, its critical core nature to the business using it, and the way in which the entrepreneur approaches the need for outside investors.

Critical components of any operation or business must be carefully constructed, tested and inserted into the operation of the business.   On the other hand, if a new free app has bugs, they can be corrected in the next automatic update, and probably without much customer noise.

So, which is better for you?

Which is better for you: rapid iteration or careful planning?  What is your case for defending your method of creating new products or services?  Have you ever been stung by releasing a “ready fire aim” project into the marketplace?