Category: Ventures & Entrepreneurship

Some years ago I had the opportunity to sit down one-on-one
with a well-known CFO in the Valley who was with his firm from a run from like
employee #5 as a start-up to the time when the company became one of most
recognized software infrastructure firms in the world. The company is public
and in largest 200 of all software firms in the world.

It is pretty rare that someone can be with a firm from early
start-up through IPO and multiple capital market transactions. The different
phases of a company often require very different skills of its executives at
each point in the game.

While the original, more general introduction to the CFO was
made through a board director, it was the CFO that reached out to me to offer a
more personal one-on-one advisory meeting. A true statement of character. When
we finally had a chance to arrange our meeting, what struck me was that this
CFO (very senior to me by a number of years) covered a spectrum of mentoring-like
questions and perspectives. The areas started off broad but became very
concrete to the software space. Some topics covered:

1. He asked me what I wanted to do professionally? Did I aspire
   to become a CFO of a large company? I
   recall telling him something to the effect that it might be difficult for me to
   pursue this as I have not spent significant time in large company finance (mostly
   entrepreneurial and project finance) nor did I have a CPA. He told me that prior
   to becoming CFO he didn’t have much of that experience either. As for my latter
   concern, he mentioned that he has had to manage accountants and the like with straight-up
   MBA training as well. He obviously has both been very successful and lived an
   unlikely path through multiple growth phases of a company. In any case, a key
   thing I took away from our meeting was that one should step back from
   time-to-time. It is sometimes very easy for one to get caught up in the
   day-to-day hustle, and prospects of a capital raise are a good time to reflect
   further on how the organization will shift around and where one wants to be
   professionally.
2. He told me that as a start-up through growth-phase CFO,
   he got involved in all the operations like I did ranging from pricing strategy,
   legal contract negotiation, to sales force training. Not something you’ll find in most finance books on
   the formal division of labor in the finance and accounting area. He told me how
   as CFO he had to train salespeople how to represent the company’s product. Efforts
   not only included interpersonal stuff like handling sales meetings but also
   included implementing some nitty-gritty details like creating product value
   propositions cheat sheets for the backs of the badges of salespeople. We also compared notes about how legal IP terms could be negotiated for a software company,
   and how market terms for structuring international partnership deals. The CFO and I also batted
   around a few points like CPU-based pricing norms in the industry versus
   emerging pricing schemes. Nevertheless, my discussion with this CFO helped to
   reinforce a concept in my mind about CXO positions. Whether the positions are “gearhead”
   (e.g., CFO) positions or other (e.g., CEO), the style of management that
   resonates with me is grounded in leadership and general business skills.
3. We compared notes on more detailed finance concerns like the need to
   report both natural P&L and functional P&Ls. Unfortunately, many accounting packages don’t
   necessarily make it easy for early-stage ventures to do everything they want to
   do (although they do frequently do things better than Tier 1 accounting
   packages). One area for me in the past has been reporting natural profit and
   loss (P&L) data (e.g., which rolls up things like travel & living
   expenses across all departments) versus functional P&L data (e.g., which rolls
   up data into the functional groups like sales & marketing so that one can
   compare information to competitive data from the 10-Ks of public companies).
   I’ve always hacked these different views together using Excel because it seems
   there are only so many ways to tag data in certain accounting packages. In any
   case, my discussion with this CFO helped to give me some other “hack” ideas as
   leveraged from large company finance (such as using formal account codes in the
   unstructured text fields [yikes!]).

In any case, although I have always looked to permanent
mentors at different phases of my career, I find it is also useful to gain
mentoring and peer input wherever you can get it. Variety is good, and there is
a lot to learn out there. No need to limit yourself to one or two people when
it comes to getting mentoring.

I thank both the board director and CFO for the mentoring
opportunity.

Jason Caplain has some good notes from an NVCA meeting today. Good overview of the where the markets are at, where the shift in the tranche financings are going, and what has happened to some of the VC partnerships (relative to past speculations). What caught my eye was this (emphasis is mine):

There is a very healthy IPO and acquisition market with good companies that have gone through bad times.

Paul Brown and I used to use a term for this. Not a very good marketing term, but for early-stage companies that survived for more than 18 months after the nuclear holocaust, cliff dropoff in customer prospect propensity to buy, and bubble 1.0 fallout … well we referred to such companies as the "cockroaches" of the industry to reflect their resiliency to survive. Looks like cockroaches are coming into favor. All together now, "We are the cockroaches."

Andy posts and points me to some Stanford business school information on Search Funds. A free, Stanford business school note/search fund study is here (before clicking: note PDF link). The Stanford site indicates:

Conceived in 1984, the search fund is an investment vehicle in which investors financially support an entrepreneur’s efforts to locate and acquire a privately held company. Recent MBA and law school graduates are using this approach more and more frequently to become entrepreneurs shortly after graduation, despite their lack of operating experience.

It’s something I thought about doing (for a passing moment) when I originally moved to Dallas – for some reason I’ve never heard the name of this type of thing. Perhaps it is because it’s kind of a hybrid between middle-market investment banking, LBO, and angel funding deals. I never learned about this type of fund at the University of Chicago’s course on Entrepreneurship, Private Equity, and Venture Capital. Additionally, I’ve not run into any friends that have used the term. Kind of funny. I suppose another explanation for me failing to catch the term "search fund" is that I tend to like straight-up equity deals better – then I can forget about all of the "complex" finance stuff associated with debt deals like unlevering the beta, using the adjusted present value(APV) method, etc. 🙂

Jason Calacanis (connector, founder of Weblogs, Inc. and respected serial entrepreneur) recounts an interesting phone call with an associate at a VC firm. An associate (as opposed to an analyst) is typically an entry-level, partner-track position within a venture capital firm. To be truthful, the nature of Jason’s conversation is similar to ones I’ve seen and heard in the past, typically between Type A personality entrepreneurs and traditional VCs.

The typical conversation plays out as follows …

VC:

• testing
• trying to understand
• testing

Entrepreneur:

• ego
• coy
• ego

Although this backdrop of talking over one another is amusing, Jason sums up some great core values about running a business:

1. Hustle
2. Passion
3. Resiliency

These are basically the characteristics of winners and entrepreneurs. To be fair though, the VC is just trying to understand the business model and slot the investment opportunity. If you applied the three things Jason mentioned to a coin-op laundry place, you would have a successful business too. It would be hard to find a VC or even a roll-up firm pursue that kind of deal though.

Update (4/7/05): Brad Feld also weighs in on Jason’s post. Looks like the conversation pattern is frequently the same the whole way along the food chain in the VC (seller)-VC (buyer) discussions.

Update (4/8/05): Paul Kedrosky at Infectious Greed has a post on the marketing value of Jason’s post.

Some of these are older references, but these contain information on stock options (Be forewarned that one needs to be very careful that one is comparing apples to apples when looking at this data or getting compensation benchmark information.):

• Brad Feld – on board compensation for directors (no cash for you early-stage directors)
• Ed Sim – on HBS compensation study
• Salary.com reference – here (one of the most detailed breakdowns I have seen on the net albeit potentially biased to include companies that have filed S-1s)

Other sources I have used for getting this information from: law firms, serial entrepreneurs, VCs, CFOs, other execs, and sometimes executive recruiters. Stock option compensation can be a bit of black art in my mind (as I mentioned in comment section of Brad’s post).

Paul Allen has an interesting post on vesting stock options based on milestones as opposed to by date. In early-stage ventures, I have seen a few forms of this type of compensation applied. In some cases, it can be implemented via vesting schedules, via controlling the grant itself, or combinations thereof (depending on the style of the stock option plan and infrastructure in place). The mechanics can involve varying levels of modifications to stock option agreement forms, employment agreement forms, letter agreements, job descriptions, board documents, etc.

Hard for me to make any generalizations, but I would say while in concept it seems very desirable, that in practice I have found it to be administratively burdensome if you take it too far or try to tailor it too much. I would probably make the same comment about non-stock option based (i.e., cash-based) project-level incentive structures as well. These can be hard to administer, keep fair, keep expectations in alignment, etc. especially if situations change during the course of a project or doing business. Maybe I’ve had good luck in that I’ve tended to work with intrinsically-motivated people though.

I have mixed feelings on this subject because one clearly wants to motivate people using whatever means possible. That said, to me the marginal benefits of having very tailored bonus compensation seems … well at times marginal and not remarkable.

Steve Shu

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