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The Board View: Slides From My Presentation at Host Perform 2019

The folks at Host Analytics kindly asked me to speak at their annual conference, Host Perform 2019, today in Las Vegas and I had a wonderful time speaking about one of my favorite topics:  the board view of enterprise performance management (EPM) and, to some extent, companies and management teams in general.

Embedded below are the slides from the presentation.

The Rule of 40 — Down, But Not Out!

Neeraj Agrawal and Logan Bartlett of Battery Ventures recently published the 2019 version of its outstanding annual software round-up report.  I highly recommend this report — it’s 78-pages chock full of great data about topics like:

  • Why Battery is long software overall
  • The four eras of software evolution
  • The five forces driving software’s accelerating growth
  • Key trends in 2018, including setting records in three areas:  (1) public company revenue multiples, (2) IPO volume (by over 2x), and (3) M&A volume (by over 2x).
  • Key trends from their 2017 report that are still alive, well, and driving software businesses.

But, most of all, it has some great charts on the Rule of 40 [1] that I want to present and discuss here.  Before doing that, I must note that I drank today’s morning coffee reading Alex Clayton’s CloudStrike IPO breakdown, a great post about a cloud security company with absolutely stunning growth at scale — 121% growth to $312M in Ending ARR in FY19.  And, despite my headline, well in compliance with the Rule of 40.  110% revenue growth + -26% free cashflow margin = 84%, one of the highest Rule of 40 scores that I’ve ever seen [2].  Keep an eye on this company, I expect it should have a strong IPO [3].

However, finding one superstar neither proves nor disproves the rule.  Let’s turn to the Battery data to do that.

When discussing the Rule of 40, most financial analysts make one of two plots.

  • They do a scatter plot with revenue growth on the X-axis and FCF margin on the Y-axis.  The Rule of 40 then becomes a line that separates the chart into two zones (compliant and non-compliant).  Note that a minority of public companies actually comply suggesting the rule of 40 is a pretty high bar [4].
  • Or, more interestingly, they do a linear regression of Rule of 40 score vs. enterprise-value/revenue (EV) multiple.  This puts focus on the question:  what’s the relationship between Rule of 40 score and company value? [5]

But that thing has always bugged me is that nobody does the linear regression against both the Rule of 40 score and revenue growth.  Nobody, until Battery.  Here’s what it shows.

First, let’s look at the classic Rule of 40 regression.  Recall that R-squared is a statistical measure that explains the dependence of the dependent variable (in this case, EV multiple) on the independent variable (Rule of 40 score).  Here you can see that about 58% of the variation in enterprise value multiple is explained by Rule of 40 score.  You can intuit that by looking at the dots relative to the line — while there is clearly some linear correlation between the data, it’s a long way from perfect (i.e., lots of dots are pretty far from the line).  [6]

rule of 40-4

Now, the fun part.  Let’s see the same regression against revenue growth alone.  R-squared here is 51%.  So the explanatory power of the Rule of 40 is only 7% higher than revenue growth alone.  Probably still worth looking at, but it sure gets a lot of PR for explaining only an incremental 7%.  It could be worse, I suppose.  Rule of 40 could have a lower R-squared than revenue growth alone — in fact, it did back in 2008 and in 2012.

rule of 40-3

In the vein, for some real fun let’s look at how this relationship has changed over time.  The first thing you’ll notice is that pre-2012 both last twelve month (LTM) revenue growth and the Rule of 40 had far weaker explanatory power, I suspect because profitability played a more important role in the equation.  In 2012, the explanatory power of both metrics doubled.  In 2015 and 2016 the Rule of 40 explained nearly 20% more than revenue growth alone.  In 2017 and 2018, however, that’s dropped to 7 to 8%.

rule of 40-2

I still think the Rule of 40 is a nice way to think about balancing growth vs. profit and Rule of 40 compliant companies still command a disproportionate share of market value.  But remember, its explanatory power has dropped in recent years and, if you’re running an early or mid-stage startup, there is very little comparative data available on the Rule of 40 scores of today’s giants when they were at early- or mid-stage scale.  That’s why I think early- and mid-stage startups need to think about the Rule of 40 in terms of glideslope planning.

Thanks to the folks at Battery for producing and sharing this great report. [7]

# # #

Notes
[1] Rule of 40 score = typically calculated as revenue growth + free cashflow (FCF) margin.  When FCF margin is not available, I typically use operating margin.   Using GAAP operating margin here would result in 110% + -55% = 55%, much lower, but still in rule of 40 compliance.

[2] If calculated using subscription revenue growth, it’s 137% + -26% = 111%, even more amazing.  One thing I don’t like about the fluidity of Rule of 40 calculations, as you can see here, is that depending what might seem small nuances in calculations, you can produce a very broad range of scores.   Here, from 55% to 137%.

[3] To me, this means ending day 1 with a strong valuation.  The degree to which that is up or down from the opening price is really about how the bankers priced the offer.  I am not a financial analyst and do not make buy or sell recommendations.  See my disclaimers, here.

[4] In fact, it’s actually a double bar — first you need to have been successful enough to go public, and second you need to clear the Rule of 40.  Despite a minority of public companies actually clearing this bar, financial analysts are quick to point out the minority who do command a disproportionate share of market cap.

[5] And via the resultant R-squared score, to what extent does the Rule of 40 score explain (or drive) the EV/R multiple?

[6] If R-squared were 1.0 all the dots would fall on the least-squares fit line.

[7] Which continues with further analysis, breaking the Rule of 40 into 4 zones.

Speaking at Host Perform 2019

hostperform

Just a quick post to plug the fact that the kind folks at Host Analytics have invited me to speak at Host Perform 2019 in Las Vegas on May 20-22nd, and I’ll be looking forward to seeing many old friends, colleagues, customers, and partners on my trip out.

I’ll be speaking on the “mega-track” on Wednesday, May 22nd at 9:00 AM on one of my favorite topics:  how EPM, planning, and metrics all look from the board and C-level perspectives.  My official session description follows:

session

The Perform 2019 conference website is here and the overall conference agenda is here.  If you’re interested in coming and you’ve not yet registered yet, it’s not too late!  You can do so here.

I look forward to another great Perform conference this year and should be both tweeting (hashtag #HostPerform) and blogging from the conference.  I look forward to seeing everyone there.  And attend my session if you want to get more insight into how boards and C-level executives view reporting, planning, EPM, KPIs, benchmarks, and metrics.

What’s the “Cause of Death” in Your Churn Reporting?

In looking at this issue across several companies, I’ve noticed a disturbing trend / missed opportunity in how many SaaS companies classify the reason for customer churn.  Roughly speaking, if companies were hospitals, they’d too frequently be reporting the cause of death as “stopped breathing.”

Yes, the patient who died stopped breathing; the question is why did they stop breathing.  In churn-speak, “yes, the customer who churned issued a churn notice and chose not to renew.”  The question is why did they choose not to renew?

Many people have written great posts on reasons customers churn and how to prevent them.  These reasons often look like hierarchies:

Uncontrollable:

  • Got acquired
  • Went bankrupt
  • Corporate edict
  • New sponsor

Controllable:

  • Failed implementation
  • Product functionality
  • Product ease of use
  • Oversold  / poor fit

These hierarchies aren’t a bad start, but they aren’t good enough, either.  A new sponsor isn’t an automatic death sentence for a SaaS product.  He or she might be, however, if the team using it had a rough implementation and was only half-satisfied with the product.  Similarly, a failed implementation will certainly reduce the odds of renewal, but sometimes people do have the will to start over — and why did the implementation fail in the first place?

Physicians have been in the “churn” business much longer than SaaS companies and I think they’ve arrived at a superior system.  Here’s an excerpt from the CDC’s Physicians’ Handbook on Medical Certification of Death — not a publication, I’d add, linked to by most SaaS bloggers:

chain of death

For example, when my dear father passed away from a stroke several years ago, I remember the form said:

example cod

(And, at the time, literally observing that it was a better way to classify churn.)

The rule above spells it out quite clearly  — “DO NOT enter terminal events such as respiratory arrest […] without showing the etiology.”  That is, “stopped breathing” by itself isn’t good enough.  Just like “sent churn notice” or “decided not to renew.”

I have not built out a full taxonomy here; classifying churn in this way remained a future item on my to-do list at the time we sold my last company.  Nevertheless, while I know it’s not easy, I believe that companies should start trying to find a way to richly encode churn reasons using this “chain” concept so as to not lose critical information in encoding their data.  Otherwise, we risk believing that all our customers churned because they sent us a churn notice (or some easily blamed “uncontrollable” event).

As one example:

  • Churned, due to
  • New sponsor, due to
  • Failed implementation, due to
  • Partner problem, due to
  • Partner training

Or, another:

  • Churned, due to
  • Corporate edict, due to
  • M&A, due to
  • Product dissatisfaction, due to
  • Oversold, due to
  • Sales training

These aren’t perfect, but I’m trying quickly demonstrate the real complexity behind why customers churn.  For example, happy customers might challenge a corporate edict issued after an acquisition — so you can’t just blame the edict.  You have to look more deeply.  If you knew that the customer fought the edict and failed, you might stop the chain there.  But if you knew they were never terribly happy with the system because they were overpromised capabilities at the start, then you should code that into the chain, too.

# # #

For more information on the warning signs and symptoms of a stroke, go here.

 

Highlights from the 1Q19 Fenwick & West Venture Capital Survey

(Revised 5/9/19, 3:30 PM to add chart from SVVCCI survey at the bottom.)

Every so often I post highlights from the quarterly Fenwick & West Venture Capital Survey, as much to share knowledge about the existence of the survey [1] as to share its current-quarter data.

This survey is important for two reasons.  First, it shows trends in price changes over time across various VC rounds.  This is useful information to see what’s happening in the market, and I suppose semi-useful information in perhaps timing your venture rounds (subject to Kellblog Rules 1 and 2 of Financing [2]).

But the really important of this survey is it tells you about terms.  Raising $20M with a 1x, non-participating preference is very, very different from raising $20M with an 8% accumulating dividend, a multiple, participating liquidation preference that ratchets from 1.5x to 1.75x to 2.0x over three years, and includes redemption rights [3].  If you’re a CEO or founder of a startup and don’t understand the prior sentence, you need to.  A good glossary, plus the F&W Survey, will help.

Let’s look at the survey highlights, starting with pricing and moving into terms.  81% of companies had financings that were “up rounds” (i.e., the share price was higher in the round last than the previous one).   On average this runs nearly 70%.

price change history

The chart shows the Fenwick & West (F&W) Venture Capital Barometer (TM), which measures the magnitude of the price change since the prior round.  In 1Q19, prices averaged 75% up since the company’s prior round, running high, but certainly not near historical highs of well over 100%

barometer history

The report does a lot of nice segmentation.  Here is direction and magnitude price change data by sector.

by industry

Now we move onto financing terms.  For definitions, see the glossary F&W publishes along with the survey.  Better yet, read the Ultimate Guide to Liquidation Preferences by Charles Yu.

Senior liquidation preferences were used in 27% of rounds [4].

senior liquidation

Of those rounds with senior liquidation preferences, 9% had multiple liquidation preferences [5].

multiple liquidation pref

Participation means that the investor doesn’t have to choose between getting their money back and getting their pro rata share of the company.  Participating preferred shares first get their money back and then get their pro rata share of what’s remaining.  That’s why they’re sometimes called “double dip” preferred.  12% of rounds in 1Q19 had participation.  While F&W doesn’t break out the data geographically, I’ve always considered participation an “East Coast” VC term.  It’s also common in Europe as well.

participation

One way to limit the effects of participation is to cap it.  However, 65% of time participation is used, it is uncapped.  35% of the time, it is capped, which sounds like an improvement, but has the perverse consequence of creating a zone of indifference for the investor.cap

There’s lots more in the F&W survey which you can find here.

Before signing off, let me highlight one other interesting survey, the University of San Francisco Venture Capital Confidence Index (SVVCCI), which in February 2019 fell to its lowest value in the past 10 years — 3.20 out of 5.00, down from 3.52 in the prior quarter.

VVCI

Unfortunately, they no longer make the full report instantly downloadable (you need to mail someone on the survey page to get a copy of it).  Nevertheless, it’s another interesting quarterly survey and I always try to read the two together.

# # #

Notes

[1] Much as I periodically post about the Bessemer Nasdaq Emerging Cloud Index for the same reason.

[2] Kellblog Rule 1 of Financing:  the best time to raise money is now.  Kellblog Rule 2 of Financing:  the best amount of money to raise is as much as you can (provided it’s at a good price).  Why?  In my opinion, too many startups press their luck, trying to delay financing in favor of hitting a few more consecutive quarters to limit dilution.  That works great — until it doesn’t — e.g., if you miss one of those quarters or if the markets turn on you.  As an example, there were two kinds of startups in 2002:  those that raised large amounts of money at crazy valuations in 2001 and dead.

[3] Terms generally do one of three things:  (a) reallocate the pie towards the investors in bad scenarios, i.e., “downside protection,” (b) provide minimum returns before others get their money, or (c) provide other rights (e.g., the right to sell the stock back to the company after N years) that can be used as forcing functions to get liquidity or control.

[4] Note that VCs buy preferred stock which is always senior to the common typically held by founders and employees. In this case, senior means senior to the other/earlier classes of preferred.  For example, if the series C gets all of its money back before the series B, then that would be a senior liquidation preference.  If series A, B, and C all got their money back on an pari passu basis, there would be no senior liquidation preference in this context.

[5] Meaning the investor gets not only his/her money back first, but some multiple (e.g., 1.5x) of it.  You can see how an investor might yield to an investor on a certain “vanity valuation” in exchange for a multiple liquidation preference, which ends up being close to a guaranteed return — e.g., if it’s on the last round, you’re first in line behind the debt with a guaranteed multiple (and maybe even more if you have participation).

My Final Verdict on Multi-Year, Prepaid Deals

(Revised 5/4/19, 10:41 AM.)

After years of experience with and thinking about multi-year, prepaid SaaS deals, my mental jury is back in the box and the verdict is in:  if you’re a startup that is within my assumption set below, don’t do them.

Before jumping in, let me first define precisely what I mean by multi-year, prepaid deals and second, detail the assumptions behind my logic in response to some Twitter conversations I’ve had this morning about this post.

What do I Mean by Multi-Year Prepaid Deals?
While there are many forms of “multi-year prepaid deals,” when I use the term I am thinking primarily of a three-year agreement that is fully prepaid.  For example, if a customer’s ARR cost is 100 units for a one-year deal, you might approach them saying something akin to:

By default, our annual contracts have a 10% annual increase built in [1].  If you sign and prepay a three-year agreement, i.e., pay me 300 units within 60 days, then I will lock you in at the 100 units per year price.

Some people didn’t know these kinds of deals were possible — they are.  In my experience, particularly for high-consideration purchases (where the customer has completed a thorough evaluation and is quite sure the system will work), a fairly high percentage of buyers will engage in this conversation.  (In a world where companies have a lot of cash, a 10% return is a lot better than bank interest.)

Multi-year prepaid deals can take other forms as well:

  • The duration can vary:  I’ve seen anything from 2 to 7 years.
  • The contract duration and the prepaid duration can decouple:  e.g., a five-year deal where the first three years are prepaid.

But, to make it simple, just think of a three-year fully prepaid deal as the canonical example.

What are My Underlying Assumptions?
As several readers pointed out, there are some very good reasons to do multi-year prepaid deals [11].  Most of all, they’re a financial win/win for both vendor and customer:  the customer earns a higher rate of return than bank interest and the vendor gets access to capital at a modest cost.

If you’re bootstrapping a company with your own money, have no intention to raise venture capital, and aren’t concerned about complicating an eventual exit to a private equity (PE) or strategic acquirer, then I’d say go ahead and do them if you want to and your customers are game.

However, if you are venture-backed, intend to raise one or more additional rounds before an exit, and anticipate selling to either a strategic or private equity acquirer, then I’d say you should make yourself quite familiar with the following list of disadvantages before building multi-year prepaid deals into your business model.

Why do I Recommend Avoiding Multi-Year Prepaid Deals?
In a phrase, it’s because they’re not the norm.  If you want to raise money from (and eventually sell to) people who are used to SaaS businesses that look a certain way — unless you are specifically trying to disrupt the business model — then you should generally do things that certain way.  Multi-year prepaid deals complicate numerous things and each of those complications will be seen not as endemic to the space, but as idiosyncratic to your company.

Here’s the list of reasons why you should watch out.  Multi-year prepaid deals:

  • Are not the norm, so they raise eyebrows among investors and can backfire with customers [2].
  • Complexify SaaS metrics.  SaaS businesses are hard enough to understand already.  Multi-year deals make metrics calculation and interpretation even more complicated.  For example, do you want to argue with investors that your CAC payback period is not 18 months, but one day?  You can, but you’ll face a great risk of “dying right” in so doing. (And I have done so on more than one occasion [3]).
  • Amplify churn rates. An annual renewal rate [4] of 90% is equivalent to a three-year renewal rate of 72%.  But do you want to argue that, say, 79% is better than 90% [5] or that you should take the Nth root of N-year renewal rates to properly compare them to one-year rates?  You can, but real math is all too often seen as company spin, especially once eyebrows are already raised.
  • Turn your renewals rate into a renewals matrix.  Technically speaking, if you’re doing a mix of one, two, and three-year deals, then your renewal rate isn’t a single rate at all, but a matrix.  Do you want to explain that to investors?

renewals matrix

  • Tee you up for price knock-off at sales time.  Some buyers, particularly those in private equity (PE), will look at the relatively large long-term deferred revenue balance as “cashless revenue” and try to deduct the cost of it from an acquisition price [6].  Moreover, if not discussed up front, someone might try to knock it off what you thought was a final number.
  • Can reduce value for strategic acquirers.  Under today’s rules, for reasons that I don’t entirely understand, deferred revenue seems to get written off (and thus never recognized) in a SaaS acquisition.  So, ceteris paribus, an acquirer would greatly prefer non-prepaid TCV (which it will get to recognize over time) to deferred revenues (which it won’t) [7].
  • Can give pause to strategic acquirers.  Anything that might cause the acquirer to need to start release pro forma financials has the potential to scare them off, particularly one with otherwise pristine financial statements.  For example, having to explain why revenue from a recently acquired startup is shrinking year-over-year might do precisely that [8].
  • Can “inflate” revenues.  Under ASC 606, multi-year, prepaid deals are seen as significant financing events, so — if I have this correct — revenue will exceed the cash received [9] from the customer as interest expense will be recorded and increase the amount of revenue.  Some buyers, particularly PE ones, will see this as another form of cashless revenue and want to deflate your financials to account for it since they are not primarily concerned with GAAP financials, but are more cash-focused.
  • Will similarly inflate remaining performance obligation (RPO).  SaaS companies are increasingly releasing a metric called RPO which I believe is supposed to be a more rigorous form of what one might call “remaining TCV (total contract value)” — i.e., whether prepaid or not, the value of remaining obligations undertaken in the company’s current set of contracts.  If this is calculated on a GAAP basis, you’re going to have the same inflation issue as with revenues when multi-year, prepaid deals are involved.   For example, I think a three-year 100-unit deal done with annual payments will show up as 200 units of RPO but the same deal done a prepaid basis will show up as 200-something (e.g., 210, 220) due to imputed interest.
  • Impede analysis of billings. If you want to go public or get acquired by a public company, financial analysts are going to focus on a metric called calculated billings [10] which is equal to revenue plus the change in deferred revenue for a given time period.  For SaaS purist companies (i.e., those that do only annual contracts with one-year prepays), calculated billings is actually a pretty good measure of new sales.  Multi-year prepays impede analysis of billings because deferred revenue ends up a mishmash of deals of varying lengths and is thus basically impossible to interpret [11].  This could preclude an acquisition by a SaaS purist company [12].

More than anything, I think when you take these factors together, you can end up with complexity fatigue which ultimately takes you back to whether it’s a normal industry practice.  If it were, people would just think, “that’s the complexity endemic in the space.” If it’s not, people think, “gosh, it’s just too darn hard to normalize this company to the ones in our portfolio [13] and my head hurts.”

Yes, there are a few very good reasons to do multi-year, prepaid deals [14], but overall, I’d say most investors and acquirers would prefer if you just raised a bit more capital and didn’t try to finance your growth using customer prepayments.  In my experience, the norm in enterprise software is increasingly converging to three-year deals with annual payments which provide many of the advantages of multi-year deals without a lot of the added complexity [15].

# # #

Notes

[1] While 10% is indeed high, it makes the math easier for the example (i.e., the three-year cost is 331 vs. 300).  In reality, I think 5-6% is more reasonable, though it’s always easier to reduce something than increase it in a negotiation.

[2] Especially if your competition primes them by saying — “those guys are in financial trouble, they need cash, so they’re going to ask you for a multi-year, prepaid deal.  Mark my words!”

[3] Think:  “I know the formula you’re using says ’18 months’ but I’m holding an invoice (or, if you wait 30 days, check) in my hand for more than the customer acquisition cost.”  Or, “remember from b-school that payback periods are supposed to measure risk, no return, and to do so by measuring how long your money is on the table.”  Or, “the problem with your formula is you’re producing a continuous result in a world where you actually only collect modulo 12 months — isn’t that a problem for a would-be ‘payback’ metric?”

[4] Renewal rate = 1 – churn rate

[5] That is, that a 79% three-year rate is ergo better than a one-year 90% renewal rate.

[6] Arguing that while the buyer will get to recognize the deferred revenue over time that the cash has already been collected, and ergo that the purchase price should be reduced by the cost of delivering that revenue, i.e., (COGS %) * (long-term deferred revenue).

[7] Happily, the deferred revenue write-down approach seems to be in the midst of re-evaluation.

[8] If the acquired company does a high percentage of multi-year, prepaid deals and you write off its deferred revenue, it will certainly reduce its apparent growth rate and possibly cause it to shrink on a year-over-year basis.  What was “in the bag revenue” for the acquired company gets vaporized for the acquirer.

[9] Or our other subsidiaries, for a strategic acquirer.

[10]  Known either as billings or calculated billings.  I prefer the latter because it emphasizes that it’s not a metric that most companies publish, but one commonly derived by financial analysts.

[11] We are testing the limits of my accounting knowledge here, but I suppose if deferred revenue is split into current and long-term you might still be able to get a reasonable guestimate for new ARR sales by calculating billings based only on current, but I’m not sure that’s true and worry that the constant flow from long-term to current deferred revenue will impede that analysis.

[12]  A purist SaaS company — and they do exist — would actually see two problems.  First, potential year-over-year shrinkage due to the write-down discussed in footnote [7].  Second, they’d face a dilemma in choosing between the risk associated with immediately transitioning the acquired company’s business to annual-only and the potential pollution of its otherwise pristine deferred revenue if they don’t.

[13] Minute 1:28 of the same video referenced in the prior link.

[14] Good reasons to do multi-year, prepaid deals include:  (a) they are arguably a clever form of financing using customer money, (b) they tend to buy you a second chance if a customer fails in implementation (e.g., if you’ve failed 9 months into a one-year contract, odds are you won’t try again — with a three-year, prepay you might well), (c) they are usually a financing win/win for both vendor and customer as the discount offered exceeds the time value of money.

[15] You do get one new form of complexity which is whether to count payments as renewals, but if everyone is doing 3-year, annual payment deals than a norm will be established.

Reacting to Feedback as CEO

The other day I saw this tweet from my friend Nick Mehta, CEO of GainSight, and it got me thinking.

feedback

It turns out that in addition to making fun music videos for company events, that Nick and I have another thing in common:  we both wrestle with finding the right balance in listening to feedback.  Since this is a topic I’ve pondered quite a bit over my 12+ years as a startup CEO, I thought I’d share those thoughts in this post.

First, you don’t get to be CEO of a startup by not caring.  You want your company to be great, you want your customers to be delighted, and you want your employees to be happy working at your company.  So I think most CEOs will have that same natural tendency towards immediate action that Nick mentions.

But CEOs who overreact both irritate employees (“so you’ve heard one side of this and it sounds like you’ve already made up your mind”) and, more dangerously, are easily manipulated.  If you find 3 people outside your office before a big meeting, each hoping to the last one to talk to you before it begins, then I’d view that as flashing yellow sign that you might be an overreactor.

On the flip side, there is some chance that the feedback is an outlier, and that reacting to it would be a mistake, particularly in terms of the opportunity cost of not having focused on something more generally important.

Finding that balance in the middle is indeed the hard part.  On one hand, CEOs are action-oriented and if they hear something plausible, they want to immediately dispatch someone to fix it.  On the other, CEOs get lots of feedback and it’s a little too easy to create a platitude shield around yourself that rationalizes feedback before it gets through — e.g., salespeople are never happy with their comp plans, employees generally don’t like their bosses, and customers always want more for their services dollar.  If you gave me 30 minutes I think I could generate about ten platitudes that would screen out 90% of feedback.  And that’s not good either.

So what should you do to find this balance?  Here are some tips:

  • Listen to everyone, all the time.  Ask open-ended questions.  For example:  “how’s your experience been working here”, “what are we like to work with as a customer”,  or “what do you think we can do better.”  Rule 1 is you’re not listening if you’re talking, so speak little and listen a lot.  Try to set up meetings as listening or feedback sessions as opposed to the default that “our CEO wants to come in and talk to you.”  Reframe it:  “our CEO wants to come in and listen to you, hear about your project, etc.”  The more feedback you get the harder it is to overreact to any one piece.
  • Remember that people have good days and bad days so do not overreact to any one incident.  (If someone really unloads on you, listen politely, take notes, and set up a follow-up call in a week or two to check back in.)
  • Listen no matter what you’re hearing.  You might hear things that are factually wrong.  You might hear things you find offensive.  You might hear things you immediately want to explain.  Recognize these as defensive reactions (even if they are appropriate defensive reactions) and remember Rule 2:  defensiveness kills communications.  Shut up, let the other person keep talking, take notes about any points you want to clarify, and discuss them at the end of the conversation.
  • Ask the “dead moose” question.  Is there any issue so big and glaring that we’re afraid to talk about and it’s like a giant dead moose in the middle of the conference room table that we’re all ignoring as we converse?  This gives people permission to put the big, often obvious, but potentially dangerous issues on the table — and get the moose off it)
  • Remember that people sometimes have agendas that shape their feedback.  Not all feedback is “pure” or unbiased in the sense that it’s a neutral voice wanting what it perceives as best for the company.  Maybe a customer is in the middle of negotiating a big contract.  Maybe an employee is angry about having missed a promotion.  Maybe a manager is trying to reorganize a department.  There’s nothing wrong with having an agenda, but it helps to know what it is when processing feedback.  Ask:  is there any bigger picture item that’s shaping this feedback overall?
  • When it comes to employee incidents, remember there are three sides to every story:  yours, mine, and what actually happened.  If you react to the first person you hear, then you’ll be teeing up a race to your office after every dispute because (as with patents) the first one to the office wins.  When faced with interpersonal disputes, remember my friend Martin Cooke’s favorite question:  “so what did Joe say when you spoke to him about this?”  If they’ve not spoken yet, then send them off to do so.
  • Beware hearsay.  It’s not allowed in court, so perhaps it shouldn’t be allowed in your office.  I don’t want to spend time with Pete saying he heard Paula say something offensive to Joe.  Tell Joe to come see me.  Or go find Joe yourself.  But we’ve all played the telephone game and know what happens to messages as they told and re-told through layers of people.
  • Remember that “not reacting now” is not the same as “not reacting.”  This is very important because “not reacting now” is probably the right answer 90% of the time.  Write it down.  Think about it.  Schedule a meeting.  But resist — and I know it’s hard — any action-oriented tendency to “do something” right now.  Once you get a reputation for going off half-cocked it’s pretty hard to shake — and very easy to get manipulated.  Time is usually your friend.
  • Remember, the plural of anecdote is not data.  Hearing the same story or opinion two to three times doesn’t automatically turn it into data.  Use surveys to gather data and use all your feedback conversations to guide topical questioning in those surveys.
  • Go get data.  You should already be running quarterly customer surveys and bi-annual or quarterly employee surveys.  Study the data in them.  Use what you’ve heard listening to people to drive special, topical lines of questioning within them.  Or, if indicated, do a special topic survey.  Once you’ve done the survey, call an optional Town Hall meeting to discuss the results.
  • Remember that 80% of an employee’s experience at your company is shaped by their manager (and, as a corollary that 80% of a customer’s experience is shaped by their account manager).  Ask specific questions about both in your surveys and when hot spots light up, go dig into them (i.e, why are so many of Joe’s employees rating him poorly on management).  Most companies are small enough that the digging can be done by live 1-1 meetings or phone calls.
  • View external data with a skeptical eye.  You can’t ignore the fact that product and company review sites exist.  All review sites have limitations — competitors can launch coordinated attacks to decrease your scores while HR can launch proactive programs to increase your scores.  My controversial advice for CEOs is to ignore these sites yourself and put your VP of Marketing in charge of product review sites and your VP of People on company review sites.  If you start to personally and immediately respond to these public posts, you are basically incenting employees to raise gripes in a public forum, as opposed to a private one such as your employee survey or coming to you directly.

Let me thank Nick for putting an important question on the table.  If you have other tips on how to answer it, please share them here.