Deals Take on a Life of Their Own

Just about every CEO denies it will happen to her. Clinically analytic CEOs and their teams, painstakingly analyze the acquisition (either their own company being acquired or a company they are intending to buy). Great process, due diligence, clear minded accountants, tax & legal counsel, all engaged and focused on the particulars. Investment bankers who sole incentive is the get the deal done. Mix all that together and what do you get? A great acquisition?

Sometimes! But quite often most deals, whether they are good or bad, end up completed. Once offers are made and dollars are discussed, deals take on a life of their own.

What does that mean? It means that even intelligent, experienced, and dedicated professionals all get caught up in very human behavior. That behavior, psychologists tell us, relates to the "investment" of time, energy and resources that have gone into getting the deal to where it is. These costs, this effort, this intense focus, leads to momentum. Like physical inertia, all of this "weight" of pointed activity aimed at getting this deal to where it is may very likely cause the deal to occur, no matter what the outcome of the final details. That is deals may occur simply because they are heading down the tracks at such a great speed (and mass of effort) that even the best laid plans may go awry and make way for a not so optimal deal.

How do you counter this?

It's not easy. Those involved in the deal, and especially those whose compensation is based upon getting the transaction completed (like investment bankers for instance!) will exert great pressure to get the deal (virtually any deal) completed. Acknowledging what smart business people call "sunk costs" and ignoring these as the final deal comes into place, under circumstances like these, is extremely difficult.

The best way we have seen to avoid succumbing to these kinds of pressures is to engage a dispassionate third party - who has the ear of the CEO - to keep a sort of pressure gauge on the transaction. Ensuring that this objective third party stays objective is the first trick. Even outsiders start to get excited about potent deals. Keeping them compensated despite the eventuality (or not) of a transaction and doing whatever you can to encourage them to point out the blemishes is your best medicine.

When deals get done, kudos are passed around, deal plaques are created, bankers get huge fees, and the good feelings abound (at least until the first quarters' combined results are tabulated). Perhaps companies should get in the habit of securing plaques for deals that don't get done, because someone realized it might not be the optimal deal?

Founder Rebounds

It seems to happen often. Expensive, heavily recruited, extremely qualified (on paper), high profile "professional" CEO brought in to take a founder-led company to the next level. Usually these situations start off with great expectation. Sometimes even a quick jolt of good performance. And then .... much more quietly, the Board reinstalls the founder to take over for a now floundering organization.

What does this mean? A bad hire. An organization that can't exist without the founder's magic. Just another phase of a company's growth.

Many companies have experienced it recently - Nike, Dell, Yahoo, and hoards of others whose names do not register as quickly.

Here are my thoughts on what might actually be happening behind the scenes:

1) It is hard to replace an icon, no matter who you are. Being the second act behind a nationally recognized figure is an awesome task. The expectations may be more than most can live into.

2) It's hard to be your own person with an icon looking over your shoulder. With the specter of the person who performed the magic that got the company to where it is hanging out in the wings, its hard to enact change. No matter what words are used, or how much support the newly hired CEO gets from the founder or the board, its a false belief that real change can occur with your predecessor standing nearby.

3) Some hires are just the wrong choices. Hiring is an art, not a science. Sometimes well intentioned boards and founders hire a person who is not capable of doing what is necessary. If it looks like a duck, smells like a duck, walks like a duck and quacks like a duck, sometimes it really is a duck!

4) Circumstances change. Sometimes the replacement hire is the right person and can adequately handle the job at the time they are hired. But subsequently the company grows, changes and the new challenges require different leadership. Leaders don't always grow at the same pace as their organization.

No matter what the reasons for the ultimate mismatch, is bringing back the founder the right answer? It's a question that remains unanswered. But perhaps its the best answer the Board can come up with at the moment.

The Power of Focus

Most early stage company failures are not caused by starving from a lack of good ideas. More often than not, instead they are choked by trying to digest too many at the same time.

Competition is fierce. Even companies with unique offerings run up against companies with orders of magnitude more of resources, experience, existing customer relationships and brand awareness. They can often favorably compete with the new entrant, even with a not-as-good solution. As the business world continues to expand, this competition will accelerate and they will set even higher hurdles for these entrants.

There is but one proven way to compete against these business Goliaths. That is to focus intensely and put all of your resources and momentum into driving that single finely honed direction. The sharper your focus the less "force" needed (or the more powerful it will become). Anything short of complete focus diffuses your efforts. Incumbents find it much easier to defend their turf when a new entrant gets distracted by things that blur the new entrant's vision.

Then why do so many early stage companies chase multiple opportunities rather than just one winning strategy? Our research tells us its risk aversion. Despite their entrepreneurial risk- taking swagger, CEOs (and sometimes their investors) like to hedge their bets, invest in several potential projects, hoping one will bear fruit. (Maybe some of this is because CEOs have short attention spans.) But this lack of complete focus is actually riskier than pursuing the one effort that really might have a shot at winning.

Confucius has been quoted as saying - he who chases two rabbits catches neither.

Barney Relationships

How many times have you been told by a bubbling senior executive of a high potential company about a relationship they have just signed with Bigco. She tells you how that relationship itself validates the value proposition of her company. And you probably believe it. After all, Bigco is a household name with legions of very smart executives who have their pick of the litter of companies with whom they could affiliate. In fact it’s not just one relationship with one Bigco that the company has rung up. In fact they have four or five with several different Bigco-like companies. Sounds impressive.

A good friend of mine, Gordon Rapkin who is currently CEO of an really cool data security firm in Stamford, CT – Protegrity, puts these kind of relationships into perspective. He calls these Barney relationships.

Depending upon your age, you either grew up with kids who were familiar with Barney the purple dinosaur, or perhaps you were a Barney fan yourself. Barney is this loveable character who caters to youngsters. You may recall Barney’s theme song. It included the words that Gordon was referring to:

I love you, you love me ….

I’m sure you can probably hum the tune.

In any case while these relationships may in fact be interesting or may even be predecessors to a more serious relationship, they are not equivalent to real market traction, unless that love also amounts to money changing hands. So while we all can all celebrate these successes, we should be very careful to realize that Barney relationships are not a proxy for a real sales or for tangible market penetration.

Don't get Bored of your Board

I had a Director who once told me his job was easy. "I just have to show up once a quarter and whine!" Thankfully, this particular director was kidding.

I have witnessed Boards who do little more. However, with the right people and some advance planning, your board can be an important corporate asset. But this requires you as the CEO to provide some leadership.

Here are a five helpful hints that will enable you to get more value from your board:

1) Prepare - If you want your board to provide you with valuable insight at your meetings, get information to them well in advance of your meeting. While you live with the information every day, the board's view of what is going on inside of your company is limited to what you provide. If they get their board books a couple of days before a meeting, they are liable to only glance at the materials in advance. If it arrives a week before, they will find the time to read it through. You may even want to circulate your agenda in advance of the meeting and ask the board's input on topics they wish to discuss.

2) Communicate - Board books are invaluable tools for your Board. However, limiting their information flow to a book once a quarter is a meager helping of corporate information. Get in the habit of communicating more often, sometimes informally. Regular calls between meetings, timely information that comes up that relates to topics you've discussed or plan to discuss, or even face to face meetings outside of regularly scheduled board meetings can help an interested board member stay abreast of what is going on and hence provide richer input. Some industrious CEOs that I have known have given their board members jobs. I don't mean they make them employees or even consultants. Rather they designate special concentrations related to issues the company is encountering and have the board member become the "lead" in this area - typically an area in which they may have some special expertise.

3) Time manage - If you allow it to happen, most of the time at your meeting will end up being a review of your last quarter's performance. These kinds of meetings tend to look a lot like a quarterly report card for the CEO. Anything you can do to avoid this should be done. The vast majority of your meeting should be spent looking forward. The board's biggest value should be as an advisor and sounding board. I usually allocate no more than 1/4 of a meeting to reviewing the past. Your agenda is the start of this trend and then effective time management during the meeting can ensure the rest.

4) Be proactive - Engage your board in the issues that matter. There is a fine line between asking for feedback and asking for direction. I would always prefer the former. In my role as a board member, I'd expect the CEO to come up with a plan and then expose the board to his plan, the underlying assumptions and rationale. But if you instead ask for direction, you may get just that. And it may be a direction that doesn't suit your desires. Don't let the board fall into the habit of making tactical decisions for you. Be proactive, do your homework, make your decisions, and then provide the transparency required to enable your board to understand why.

5) Avoid surprises - If you are going to take on just one of these five recommendations, make this the one! Boards hate surprises. The Board's role is to look out for the interests of the shareholders. Surprises make the board uncomfortable in that role. Surprises connote a betrayal of trust and result in a Board that questions everything and pulls tight on the slack they have given to the CEO. Delivering bad (or even good) news surprises in close to real time, is a much better prescription for the CEO who wants to continue to ensure a healthy board relationship.

Man’s Best Friend

The prevailing view in national politics is that if you want a friend in Washington, get a dog. This same axiom is true for the CEO of a venture-backed company.

Sure, while they were courting you, your venture capitalists said wonderful things about your company. They applauded your past successes. They told you of their hands-off style and how they were there to help you navigate (only) the strategic issues. They persuaded you that they brought more than money to the table. They brought their contacts, their experience, the synergy of their other portfolio companies, and of course their “brand.” But what they probably left out of the equation is that the sole reason they invested in your company is their expectation of a healthy return on their investment. In other words, they are in it for the money!

Venture capital is often a necessary evil to get you, your colleagues and your company to the next level. Often times you can’t get there without it. And in many cases it is a badge of success for an entrepreneur. Venture backed companies get more attention from the press, tend to grow faster, and, in fact it is much more likely that you will accomplish an IPO with venture backing than without.

Oh sure, you say, you always knew VC’s were in it for the money. And in fact, you’re probably in it for the money too! Otherwise, why would you be putting in those long hours, enduring the hardships of limited resources, competitive pressures and dealing with hard-to-please employees and investors. But while this may be a similarity between you and your VC, there is an important difference. While you both may be in it for the money…they are in it ONLY for the money.

You, on the other hand, may have to maintain friendships and relationships with your employees, you may have your name on the line with your angel investors, friends, or family. It is on you whom the vendors are taking their chances. And perhaps you have some desire to continue running your company. You need to make decisions that may have implications that go beyond just plain money. These “other” considerations all are part of what makes you a CEO. But your VC ultimately wants nothing to do with them.

VC’s really only care about the money. You and your company are just a vehicle to get them to their goal of a return on their investment. If something, anything extraneous, gets between them and their return, like you or your “other” considerations, you will likely find yourself alone.

If you haven’t experienced this yet, just wait until your try to raise the next round of capital. Or, you miss you numbers one time too often. Or, you are forced to sell your company at a price that is not quite what the venture guys were hoping. Or perhaps worse yet, you go through a liquidation. Then see who ends up with what’s left.

So next time you are sitting at a board meeting, and perhaps things are going well enough to let your guard down just a bit, don’t consider for an instant that they the guy next to you is your friend. Unless he’s got long furry ears and a tail, think again!

Time to Replace Yourself

Fortune Small Business recently posted an article with this title. While I believe the article is a pretty good rendition of what founders go through when they determine they need some help, the issues touched upon are just the tip of the iceberg and are probably only appropriate from a founder’s point of view. But having been the replacement CEO for four different founders, as a successor to a founder you are often fighting an uphill battle trying to do things differently than the founder - especially when the founder is still peering over your shoulder. Often the founder/CEO may decide they need help, but not know how to accept it. In one of these companies, I used to joke that the founder encouraged me to initiate any changes that I thought were necessary as long as he agreed. This was a difficult charge, since doing only those things that the founder agreed with potentially doomed us to relive the past and not improve the business.

It is a unique founder indeed who is willing to leave a successor alone and let them make what the founder may feel are mistakes in order to take the business to the next level. In my experience, the founders who figured out how to get out of the way and give the new CEO the same full reign they maintained when they were running the show, are the ones who ultimately were able to reap the rewards of a successful liquidity event. The others were drastically different outcomes.

Of course you’ve got to have the courage and the foresight to hire the right successor. I am an advocate of “try before you buy” - hiring a successor CEO as a consultant or in a less invasive role before making a final succession decision. But continuing to hold tight on the reins after making that decision can compound the issues rather than solve them.

I’ve often considered that the best prescription for a founder who has determined that they need to hire a new CEO, is to get completely out of the way - which may require leaving the company - in order to empower the new CEO to make the necessary changes.

Large companies tend to understand this when replacing a CEO. Take the example of GE. Welch engaged in an extensive process to identify the appropriate successor. But when Welch stepped down from the role, he quickly extricated himself from the business altogether to enable Immelt to lead the company in an entirely new direction.

Hiring is Hard

Most people do it poorly. But in early stage companies, the people you hire (and fire) to form your executive team are critical to the success and often the survival of your business. Any early stage CEO must read Marc Andreessen's post Hiring, managing, promoting, and firing executives on this topic.

Marc nails it as he discusses how and who to look to hire, how you know if they are right for the role, how you can tell if they are succeeding, and how you know when it's time to pull the plug.

As Marc suggests, getting it right 50% of the time ranks up there as a best practice result. So figuring out if you have done it right, earlier rather than later, is essential. His post offers a checklist of thoughts before you make (or keep) that big mistake.

Business Models Matter

Have you ever tried to swim against a strong current? Even if you are a good swimmer, almost no matter how hard you try, its very difficult to make any forward progress.

This is a similar situation for companies who have business models that work against them. [Business models are roughly defined as the value proposition that your company brings to the market.] No matter how hard you work, or how smart you are, or how great your solution, you don't seem to make any money.

Smart CEOs attack business models first when founding or taking over the leadership of a business. Once they have that down, everything else is much easier to handle. In fact history has shown us that even great CEOs will likely fail with a poor business model and in fact the converse, poor CEOs often are propped up and succeed with great business models. So rather than continuing to swim against the tide, consider altering your model.


So what's a good business model look like?

We have found that good business models have the three characteristics that match up with an immediate, a future and a long term time frame.

Great Profit Margins
Stickiness
Defensibility

Great profit margins - Business thrives on this. Seems simple. However, there are untold numbers of businesses that don't get this. The work hard, sell lots of whatever it is they are producing, and like the old proverb, "will make it up in volume." Actually that is what many of these businesses believe (hope?) - that once their volume is sufficient, they will become profitable.

Instead, smart founders and CEOs seek out ways to make their business profitable today. Clayton Christensen used the term "impatient for profits" in his book Seeing What's Next. It's important to ensure that your business today (or as soon as practical) earns profits and that those profits are not necessarily dependent upon reaching some volume threshold. It certainly makes it easier on your scarce capital to do it this way. Businesses that clearly differentiate themselves from the competition (have a unique offering) generally have an easier time making a profit. They tend to have selling prices that have no direct relationship to their cost - typically large spreads between the two. Instead their prices are based upon their value they deliver to the purchaser. Scarcity helps as well - if you are the only one delivering this solution to a target market - you can often name your price.

Severing the markup-over-cost relationship can accelerate any business model. There certainly are great examples of this in the market, often associated with luxury goods that create a perceived value in the mind of the buyer. But great margins are sometimes found in more innovative ways. I've experienced two technology companies that saw this light. Tangoe, an application software company based in Orange, CT found that their telecom expense management was so good it saved big companies millions of dollars. Rather than just charge some amount that amortized the steep development costs of their software, Tangoe has begun to charge based upon "sharing" that value with the customer. Another company based in Hickory, NC, Transportation Insights, had the insight (pun intended) to charge their customers based upon how much their freight logistics services save their customers, generating large percentage profits for this young company.

At one company that I lead, we found that offering our software as a service (back before Salesforce.com made this term vogue) was our key to juicing our margins. After listening hard to our customer base, we heard there was great value in not just handing them the CDs with the code, but in fact in running the application for them (in this case employee equity management) provided more value and hence higher profit margins. (This move also had an ancillary positive impact on the idea we'll discuss in the next post - stickiness.)

So just don't take the business model you've been handed for granted. Be sure it works for you! If not, no matter how good you are, its probably a critical enough factor to rethink whether this is really a business for you.


Good business model provide enticing profit margins - so enticing that your well-heeled competitors might view this territory as ripe for their expansion. While a good business model (and a great product) might generate some nice short term profits, how do you keep this good thing going?

We call this next stage Stickiness. Stickiness is that quality that keeps your customers loyal to your solution.

Stickiness has another dimension as well. The stickier your solution, the less effort you should have in deriving additional revenue from that same client. Sticky solutions are the "gift that keeps on giving." You've probably been told that is is much cheaper to continue to keep a customer than to try to find a new one. Stickiness trumpets this characteristic ... and more!

Often times smart companies can create solutions that are sold once but paid for on an on-going basis. Subscriptions, leases, maintenance, outsourcing, services, royalties and the like are all examples of long term payouts from a single sale. If you can morph your business model into one that has recurring revenue, rather than a one-time fee, do it! Salesforce.com, mentioned earlier, pioneered a concept called SaaS - Software as a Service. Rather than do what everyone else in the software business was doing - selling based upon a large up front perpetual license fee and relatively small annual maintenance fees (usually running 15-20% of the license fee), they decided for this and other good technological reasons to charge a use fee - based upon the number of users, charged annually. This model changed the dynamics of the software industry. Sell a customer today, collect 100% of this year's fees this year, and then be virtually guaranteed next year's fees next year too! Compare that to the typical company that received 100% of this year's fees today and only 20% of that fee next year. Salesforce.com's model almost guaranteed growth - just by selling one more incremental customer.

Other sticky models are created through a community model. By community, we mean that the company has done something more than just sell you today's solution. They have developed a brand that you become loyal to because they delivered what they promised and they provided the reinforcement for you to continue to identify with that solution. eBay created a great community model that actually became more attractive the more customers it captured - there were more reasons to attend an eBay auction each time a new customer joined.

Each of these characteristics provides an ongoing value proposition for each new customer - one that will continue to generate benefits for the company - and for the customer. Done right, these can be like the proverbial snowball - gaining (revenue) volume at an accelerating pace.

Sticky solutions enable CFOs to sleep at night. Sticky solutions generally have a more predictable and less lumpy revenue flow - characteristics that are valued on Wall Street.

So now you have a great profit margin and a reason for your customers to stick around; what else do you need?



With both profit margin and stickiness, you may be set for the short and middle term. But what about the long term, once competitors have enough time to regroup and mount an attack?

We used to call this a barrier to entry. Most Venture Capitalists used to quiz their founder CEOs on how they were going to maintain their position in the light of big competitors targeting them.

Like security, no protection is fool proof. What you need is to find as much protection as you can today and then run like hell to build yourself as sticky a solution as you can. The government gives you some protection if you have developed something novel by issuing patents and copyrights. Each gives you a bit of a legal monopoly (hence scarcity) on your particular invention. But intellectual property protection is usually not available for services or other non-proprietary businesses, and patents wear out and are costly to defend, copyrights are relatively weak protection, so you will need to take much of this matter into your own hands.

So ultimately your long term protection will be built on establishing yourself, through both bulk and brand. Bulk comes from just that - getting big quick. Companies like RIM who invented the Blackberry was a company just in this situation. They initially relied on patent protection which ultimately backfired (they had to pay almost $1 billion for allegedly violating someone else's patent). But even with that big settlement, they didn't have to fold their tent and go home once their IP barrier was breached. Instead they were large enough to withstand the financial impact, had created a very loyal user base, and continued to innovate off of their original design.

There are always obstacles to customers changing brands - sometimes they are simply psychic impediments such as "I don't know how that new product will work - but I do know that the one I use now works fine" - or sometimes there are real switching costs - like having to convert one's data to a new format. But smart companies rely much more on the positive side of attractiveness to retain their loyal customers. They provide a great continuing customer experience - one that keeps the customer from even thinking about changing in the first place.

Together, great profit margins, stickiness and a good defensive strategy can create long term value for the owners of a valuable solution.

Presentation to Long Island Software CEO Forum

Last week I presented "Lessons Learned" to a group of software company CEOs on Long Island. Below, using a new tool that I found called "SlideShare," I've embedded the presentation. Let me know any thoughts about it and/or slideshare by leaving a comment.

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