The Curse of the Megaround

With what everyone seems reluctant to call a bubble in late-stage, private financing in full swing, I thought I’d do a quick post to drill into a concept I presented in my 2015 predictions post, something I call the curse of the megaround.

We will do that by examining the forces, and the winners and losers, surrounding a megaround.  Let’s start with a hypothetical example. Company X raises $200M at $1B pre-money, giving them a $1.2B post-money valuation.

Champagne is popped, the financing is celebrated, the tech press bows, and the company is added to many unicorn trackers.

Now what happens?

  • The CEO is under immediate pressure to invest the additional capital.  If you take the rule of thumb that most venture rounds are designed to last 18-24 months, then a $200M raise implies a cash burn rate of $8 to $10M/month or $25 to $30M/quarter.  That is an enormous burn rate and in many cases it is difficult or impossible to spend that much money wisely.
  • The CEO is under heavy pressure to triple the value of the company in 2-3 years.  The investors who do these rounds are typically looking for a 3x return in 2-3 years.  So the CEO is under huge pressure to make the company worth $3.6B in 2-3 years.
  • This, in turn, means the CEO will start investing the money not only in promising growth initiatives, but also dubious ones.   Product lines are over-extended.  Geographic over-expansion occurs.  Hiring quality drops — in an attempt to not fall behind the hiring plan and lose all hope of achieving the numbers.
  • In cases, money is waste en masse in the form of dubious acquisitions, in the hope of accelerating product, employee, and customer growth.  However, the worst time to take on tricky acquisitions is when a company is already falling behind its own hypergrowth plans.
  • All of this actions were done in the name of “well, we had no hope of making the plan if we didn’t open in 12 countries, hire 200 people, add 3 product lines, and buy those 2 companies.”  So we may as well have tried as we would have been fired anyway.  At least we gave it our best shot, right?
  • This often comes to a head in a Lone Ranger moment when the board turns on the CEO.  “Didn’t we agree to that hiring plan?  Didn’t we agree to those product line extensions?  Didn’t we agree to that acquisition?” the CEO thinks.  But the board thinks differently.  “Yes, we agreed to them, but you were accountable for their success.”

Yes, being CEO can be a lonely job.  This is why I call it the curse of the megaround — because it’s certainly a curse for the CEO.  But the situation isn’t necessarily a curse for everyone.  Let’s examine the winners and losers in these situations.

Winners

  • The founders.  They get the benefit of a large investment in their company at low dilution without the downside of increased expectations and the accountability for delivering against them.
  • The private equity fund managers.  Provided the turmoil itself doesn’t kill the company and new, more realistic plans are achieved, the PE fund managers still get their 2+20 type fee structure, earning 2% a year baseline and 20% of the eventual upside as carry.  In a “more normal” world where companies went public at $300M in market cap, there would be no way to earn such heavy fees in these investments.

Losers

  • The CEO who is typically taken out back and shot along with any of the operating managers also blamed for the situation.
  • The company’s customers who are typically ignored and under-served during the years of turmoil where the company’s focus is on chasing an unreachable growth plan and not on customer service.
  • In the event the company is sold at a flat or down valuation, the common stock holders (including founders and employees) who can see their effective ownership either slashed or wiped-out by the multiple liquidation preferences often attached to the megaround.  (People love to talk about the megaround valuation, but they never seem to talk about the terms that go with it!)
  • The private equity limited partners whose returns are diminished by the very turmoil their investment created and who are stuck paying a high 2+20 fee structure with decade-ly liquidity as opposed to the 1% fee structure and daily liquidity they’d have with mutual funds if the companies were all public (as they would have been pre-Sarbox.)
  • The private equity limited partners who ultimately might well end up with a down-round as IPO.

In some situations — e.g., huge greenfield markets which can adopt a new solution quickly and easily — a megaround may well be the right answer.  But for most companies these days, I believe they are more curse than blessing.

Host Analytics World: Some Key Takeaways

We are having an amazing time at Host Analytics World this week in San Francisco.  I’m thrilled with size (over 700 people), the positive energy, and the learning/sharing that’s taking place at this event.

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Probably the single best thing I’ve heard from customers at the conference is this:

“I use a lot of cloud software and … the relationship you have with your customers is unique.”

The reason this makes me so happy is that’s what our strategy is all about.  We are a 100% customer-focused SaaS vendor and a huge part of my strategy here is to build a real, deep, sincere customer-success culture.  So any time I hear an echo back from our customers that is what they are seeing/feeling it makes me very happy.  And I’ve heard plenty of those echos this week.

The other big things I’ve seen thus far:

  • Tremendous interest in modeling and our new Modeling Cloud offering.  Organizations are doing more modeling than ever before and they want a modeling solution that leverages Excel and ties together disparate departmental models into a single enterprise model.
  • Huge support for our intelligent leverage of Excel strategy.  AirLiftXL, SpotLightXL, and our web-based Excel grid allow customers to leverage their existing models and, more importantly, skills / human capital in the context of a proper planning system.
  • Major interest in tying together sales and financial planning.  This is a real hot button in finance right now as sales planning is increasing done by sales ops and/or sales strategy groups outside of finance and in software not linked to the central planning system.
  • Big interest in our new Aviso partnership as part of our strategy to better link sales and finance.  Aviso delivers predictive analytics that not only help forecast sales but actually guides sales management to the most important opportunities in the pipeline.  In general, customers seem to support our strategy to stay focused on EPM and not extend ourselves in adjacent fields where best-of-breed players already exist.
  • And finally, I’d be remiss if I didn’t introduce our new mascots, Tick and Tie.

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Career Advice: Simplifiers Go Far, Complexifiers Get Stuck

“If you can’t explain it to a six year-old, you don’t understand it yourself.”  – Albert Einstein

There are two types of people in business:

  • Simplifiers:  who make complex things simple
  • Complexifiers:  who make simple things complex

Quick joke
Question:  What does a complexifier call a simplifier?
Answer:  “Boss.”

Somewhere, somehow, some people decided that in business you need to make everything complicated and speak using business jargon.

Well, that’s an interesting proposal and I’m not necessarily opposed to it, so let me run it up the flagpole so we can kick it around as a strawman.   Since I hear the idea has some traction in the field, let me reach out to the guys upstairs, and we’ll see if we have the bandwidth to go forward with this.  If the cost is North of $100K, I may have to backburner it, because we need to keep some dry powder pending the results of the strategy meeting — where I know we’re considering a pivot.  Right now, the long pole in the tent isn’t marketing but strategy so let’s keep lines open.  Kudos to the team for coming up with a such a great value proposition, but for now I’m afraid can’t lean in on this one.

That’s one way of hiding behind complexity: making yourself flat incomprehensible.  While that may impress your peers, your subordinates will mock you and your superiors will ask to speak to someone else.  As I argued in this post, when dealing with senior people you need to speak clearly and, above all, answer the question.  In most organizations, while jargon and doublespeak may be prevalent in middle management, they are nearly absent in the boardroom.

The other way of hiding behind complexity is not linguistic but conceptual:  always finding an upstream or bigger-picture issue that will block progress at the lower level.  Consider this statement:

I’d like to cut over to the new process, but we haven’t completed the training yet.

Is this, as it appears, a valid reason for not making progress on moving to the new process or is it passive resistance disguised as a reason.  For example, I don’t want to move to the new process so I keep “having trouble” scheduling the training.  Or is bona fide complexification?  If the training can be boiled down to one page that everyone can read in 5 minutes then just cut over.

Remember the old saw:

When you ask the time, some people will tell you how to build a watch.  Others will tell you how to build a Swiss Village.

My test for spotting complexifiers is look for the following pattern:

  • Slow progress on results
  • Blamed on everything being difficult or complicated
  • With a tendency to find artificial prerequisite activities that sound plausible, but on further examination aren’t.

Things are as complex as we want to make them. Most of the time complexity is an excuse for either not wanting to do something or not knowing how to do something.

My advice:  strive to make things simple.  Seek to understand them.  Struggle to find apt metaphors for them.  If you’re not burning real energy trying to simplify things for you audience, you are most like a complexifier.  If so, the next time you’re about to explain to someone why something take so long, is so complicated, or requires 5 steps to be completed before the start, ask yourself — do I really believe this or I am making it complicated because I either don’t want or don’t know how to do it.

Congratulations to MarkLogic on Unicorn Status

Congratulations to MarkLogic on achieving “unicorn” status with yesterday’s announcement of a $102M financing at a $1B+ pre-money valuation.

CB Insights now has MarkLogic officially on their unicorn tracker where they are in the company of a rather amazing other 102 startups all with $1B+ valuations, with a combined valuation of a staggering $371B.

Congratulations to the many team members with whom I worked during my time there (2004 to 2010), and a few names immediately spring to mind in that regard:  Max, Ian, Paul, Ron, Wayne, Mary, Ponz, Larry, Mark, Randall, Chris, Enrique, Dave, Ann, JT, Josh, Kelly, Matt, Norm, Denise, and of course, Brother Makely.

And I should also thank MarkLogic, in particular Bob and Dale, for being a Host Analytics customer — one of many high-growth, high-tech companies that choose Host Analytics as a cloud-based EPM system that you won’t outgrow.

Conflict Avoidance Causes Conflict: Managers Too Nice for Their own Good

One thing I try to teach all new (and many old) managers is the simple, somewhat counter-intuitive rule that conflict avoidance causes conflict.

Example:  a manager has problems with an under-performing employee, but doesn’t tell them that their work is below expectations and they need to ship up.  Over time the manager gets increasingly frustrated with the work quality and eventually fires the employee abruptly in a heated conversation.

The employee has no idea his work was sub-par, had been repeatedly reassured by his manager that things were OK, had received a solid annual performance review, and thus leaves the organization angry and confused.  This results in a downstream lawsuit, with the company entering in a weak position because (due to the lack of dialog) there is little or no “paper trail” documenting the performance issues.

Now the company is looking at a legal battle that will cost or settle in the tens of thousands of dollars — if not more — all because a manager was too afraid to say “you write bad code” or “you run events poorly.”

And why did the manager never say these things?  Because they were avoiding conflict.

This pattern happens over and over in business:

  • Managers unhappy with supplier performance and simply cancelling a contract rather than trying to work together to improve service.
  • CEOs and boards getting alignment and everyone being too polite to face the issue until it comes to a major boardroom blow-up.
  • Directors quietly passed over for promotions for reasons they don’t understand until they eventually quit the company.
  • Non-native English speakers getting glass-ceiling-ed due to their communications skills, but their manager is too afraid to put the issue on the table.

In each case, conflict avoidance results in [1] a lose/lose situation and [2] more conflict.

So to phrase a slightly longer version of my rule:  conflict aversion leads to pressure build-up which leads to explosive conflict.

Why does this happen so often in Silicon Valley?

  • In general, we are all taught to be nice as we grow up (e.g., “if you haven’t got anything nice to say, then don’t say anything at all”).  Many people have trouble adapting that principle to the workplace.
  • Silicon Valley is full of introverted math and science types who enjoy working on hard conceptual problems but who, for the most part, would rather have a root canal than sit down with someone to discuss a conflict situation.

Overcoming this isn’t easy.  Hard as it may be to believe, I used to be “nice” myself.  But then I realized that being nice wasn’t actually being nice, it was being conflict averse, avoiding tough situations to the detriment of both parties until things come to a typically explosive ending.

Most of the articles you’ll find on the web about work conflict are about peer-level conflict, such as this nice write-up on UC San Diego’s HR site.  But the most dangerous avoided conflicts are those between manager and subordinate, where the manager simply abdicates the responsibility for doing his/her job.  Over time, this will cost someone their job — either the manager for failing to manage, or the employee, often in what he/she perceives as a blind-side attack.

Here’s a nice Harvard Business Review blog post on giving negative feedback that any conflict-averse manager should read.  If your problem runs deeper, then you should read Difficult Conversations, an excellent book in its own right but also one with a title that provides part of the job description of any senior executive.

What do CEOs do for a living?  I’d argue three things:

 

Survivor Bias in Churn Calculations: Say It’s Not So!

I was chatting with a fellow SaaS executive the other day and the conversation turned to churn and renewal rates.  I asked how he calculated them and he said:

Well, we take every customer who was also a customer 12 months ago and then add up their ARR 12 months ago and add up their ARR today, and then divide today’s ARR by year-ago ARR to get an overall retention or expansion rate.

Well, that sounds dandy until you think for a minute about survivor bias, the often inadvertent logical error in analyzing data from only the survivors of a given experiment or situation.  Survivor bias is subtle, but here are some common examples:

  • I first encountered survivor bias in mutual funds when I realized that look-back studies of prior 5- or 10-year performance include only the funds still in existence today.  If you eliminate my bogeys I’m actually an below-par golfer.
  • My favorite example is during World War II, analysts examined the pattern of anti-aircraft fire on returning bombers and argued to strengthen them  in the places that were most often hit.  This was exactly wrong — the places where returning bombers were hit were already strong enough.  You needed to reinforce them in the places that the downed bombers were hit.

So let’s turn back to churn rates.  If you’re going to calculate an overall expansion or retention rate, which way should you approach it?

  1. Start with a list of customers today, look at their total ARR, and then go compare that to their ARR one year ago, or
  2. Start with a list of customers from one year ago and look at their ARR today.

Number 2 is the obvious answer.  You should include the ARR from customers who choose to stop being customers in calculating an overall churn or expansion rate.  Calculating it the first way can be misleading because you are looking at the ARR expansion only from customers who chose to continue being customers.

Let’s make this real via an example.

survivor bias

The ARR today is contained in the boxed area.  The survivor bias question comes down to whether you include or exclude the orange rows from year-ago ARR.  The difference can be profound.  In this simple example, the survivor-biased expansion rate is a nice 111%.  However, the non-biased rate is only 71% which will get you a quick “don’t let the door hit your ass on the way out” at most VCs.  And while the example is contrived, the difference is simply one of calculation off identical data.

Do companies use survivor-biased calculations in real life?  Let’s look at my post on the Hortonworks S-1 where I quote how they calculate their net expansion rate:

We calculate dollar-based net expansion rate as of a given date as the aggregate annualized subscription contract value as of that date from those customers that were also customers as of the date 12 months prior, divided by the aggregate annualized subscription contract value from all customers as of the date 12 months prior.

When I did my original post on this, I didn’t even catch it.  But therein lies the subtle head of survivor bias.

# # #

Disclaimers:

  • I have not tracked the Hortonworks in the meantime so I don’t know if they still report this metric, at what frequency, how they currently calculate it, etc.
  • To the extent that “everyone calculates it this way” is true, then companies might report it this way for comparability, but people should be aware of the bias.  One approach is to create a present back-looking and a past forward-looking metric and show both.
  • See my FAQ for additional disclaimers, including that I am not a financial analyst and do not make recommendations on stocks.

Why Modeling Cloud Matters in EPM and Operational Planning

Two weeks ago, Host Analytics launched an amazing new product called Modeling Cloud.  Built by an elite team of some our most experienced developers, Modeling Cloud represents a breakthrough in cloud enterprise performance management (EPM).

In this post, I’ll discuss why Modeling Cloud matters to customers, to the market, and to the company.

Why Modeling Cloud Matters for Customers

  • Ability to build non-financial models. Planning and budgeting tools are built for planning and budgeting.  As such, you want them tied to the general ledger (GL) so, for example, you can easily get actual vs. plan for periodic reporting.  But that requires a level of financial intelligence that can become cumbersome; in a typical planning system every line needs to tie to an account in the GL, be a debit/credit account type, be associated with a legal entity, and have an associated currency.  That intelligence, which is so wonderful when making budgets, becomes baggage when you just want to build a model — for example, of bookings capacity given productivity and ramping assumptions, or new sales model given advertising spend, conversion, trial, and purchase rates. That’s why most models today are built in Excel and completely disconnected from the financial planning system.
  • Ability to integrate non-financial models. The problem with departmental Excel-based modeling is that everything ends up disconnected from the central financial planning.  Consulting can tell you what happens to billings if you hire 5 more consultants in the East and sales can tell you what happens to bookings if you hire 6 more salesreps in the East, but you need to start mailing spreadsheets around if you want to see the financial outcomes (e.g., revenue, EPS) of such changes.
  • Enterprise-wide scenario analysis. The beauty of connecting departmental modeling to the corporate financial plan is that you can perform enterprise-wide sensitivity analysis.  Say we’re thinking of making a big Eastern region push next year.  When the models all tie to the financial plan, we can see the financial outcomes for the company associated with such a push, and what it means to setting expectations with board and Wall Street.  This captures the real spirit of what is often called driver-based planning.
  • The bookings-to-revenue bridge. Models can help the finance team better forecast revenue because sales tends to be bookings-oriented whereas finance is revenue-oriented.   Everyone knows that given a pipeline of 100 opportunities there can be scores of combinations where sales hits the bookings target, but each one produces different revenue depending on the composition of the orders.   This is also, more subtly, true of sales expense because any given combination will consist of a given set of deals, for a given set of products, by a given set of saleseps, and each product may have different incentives on it, and each salesrep may be in a different stage of acceleration in their compensation plan.  By modeling bookings and doing scenario analysis of various combinations of orders, finance can better predict revenue, expense, and ultimately EPS.  In a world where a minuscule EPS miss can knock off 20% of a company’s valuation in a heartbeat, this is a critical capability.

Why Modeling Cloud Matters to the Market

  • Cloud penetration.  EPM is under penetrated by the cloud, with cloud-penetration of less than 5% today.  That means that 95% of all EPM systems sold in 2014 (between $3-4B worth) were on-premises.  By comparison, sales force automation (SFA) is about 50% cloud-penetrated.  While cloud-based planning and budgeting tools have existed for over 5 years, most cloud vendors are still working on completing their suites, with a handful introducing consolidation only in the past one to two years, and just two vendors offering a modeling engine in the cloud.  While it’s not the only factor hindering cloud penetration, rounding out cloud EPM suites will definitely help accelerate moving EPM to the cloud.
  • Market penetration.  Cloud aside, EPM is an under-penetrated market, overall. A recent survey by Grant Thornton, 40% of companies reported that they weren’t using any EPM system, relying only spreadsheets for FP&A work.  This implies the $3-4B EPM market could nearly double simply by better penetrating target customers.  And the best way to penetrate these companies is not by attacking Excel, but instead to bring an intelligent Excel strategy that makes it easy to import and build both budgets and models that are connected to the financial planning system.

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  • Customer penetration.  EPM is under-penetrated within EPM-consumer companies.   Many EPM customers start with a dream of true enterprise-wide planning, but fallback to EPM deployment only within finance and rely on emailed spreadsheets for the “last mile.”  That’s too bad because mailing spreadsheets is both insecure and error-prone.  This situation develops often in on-premises EPM because the hassle of deploying the software across all potential users is simply too high and because the software itself is built for finance not end users.  Cloud EPM — with cloud modeling — will help with improving customer penetration not only because it introduces new reporting and slicer/dicer options, but also because — in the case of our Modeling Cloud product — it introduces the new ability to build and manipulate sub-models which give end users the data they want — and only the data they want — without having to rely on IT for configuration.

Why Modeling Cloud Matters to Host Analytics

  • Unique position.  With Modeling Cloud in the product line, Host Analytics now has the most comprehensive EPM suite in the cloud.  If you look at our primary cloud competitors, one does low-end planning and budgeting, one does visualization and mobile, and the other does cloud modeling but has only both new and functionally thin applications for core finance.
  • The finance choice.  Host Analytics has always been the finance department’s choice when it comes to core EPM (planning, budgeting, consolidation).  That’s because experienced finance people understand the depth and breadth that we bring to the cloud and aren’t interested in buying either unproven solutions or solutions that they will outgrow.
  • The operations choice.  With Modeling Cloud, Host Analytics is now also the operations choice.  Be it sales ops, marketing ops, or services ops, Host Analytics allows ops departments to do the planning and modeling that they require — and to do so in a way that easily integrates with the core financial planning system.  This gives them the best of both worlds — the ability to build any model they could build in Excel, using Excel formulas (and even using an Excel front-end if they so desire) and to do so in a way that automatically integrates with the core financial plan.
  • The best architecture.  Only Host Analytics offers a true multi-dimensional (i.e., OLAP) backend and an architecture built atop cloud-native, dynamic, elastic, NoSQL technology where we deliver phenomenal multi-dimensional analysis and leverage modern/standard components for managing physical storage, sharding, and parallelism.  This provides us with a huge advantage going forward both in terms of productivity and scaleability.

It’s been about 2.5 years since I joined Host Analytics and I’m quite proud of the work done by our entire R&D team in industrializing the core products, introducing a new layer of solutions, and now rolling out the industry’s most innovative cloud-based modeling engine.