Strategic Execution Part 3: The Six Stages of the Corporate Development Playbook
In previous blog posts, I explained what strategy is, why it is needed, and how it is developed and executed; at least in a reference process for a growth stage company. In this post, I will outline the six stages of strategy execution for growth from inception to Exit; mastering the highly differing and even contradictory demands and focuses of each of these independent stages is the key to successfully navigating the entire journey.
The six stages or plays of growth of any company are as follows:
1. Company Launch or Customer Development
2. Product / Market Validation
3. Business Model Validation
4. Product / Market Growth
5. New Product / Market Extensions
Each of these six stages is uniquely different and requires a different focus, management styles, metrics, and talent to achieve the unique strategic objectives of each stage. Some of these stages can be accomplished quite quickly; others may take years. The stages may take on unique characteristics, and each company is unique in its journey, but I have found these stages to be common to every company with which I have worked or that the company was in a turnaround driven by skipping or improperly executing one of these stages.
Some might want to add acquisitions (and divestitures) into this; while the act of acquiring and integrating (or divesting) other businesses is a distinct operation with many considerations unique to the action, I prefer to classify them as a strategy driven tactic that is one of several possible ways to implement within New Product / Market Extensions, and possibly Business Model Validation and Product / Market Growth. Looking at acquisitions and divestitures this way can help focus the purpose of the acquisition or divestiture on the method by which it increases corporate value rather than the glamor of the transaction itself. Recognizing that the process of acquiring often destroys at least some corporate value and success in M&A comes from creating more value through the acquisition and integration than is destroyed in the process.
These stages can be placed into a logical sequence as shown in Figure 1. It is important to note that while some of these stages may end up being accelerated and streamlined by circumstance, each represents a different problem being solved. For this reason, all product / service introductions follow a basic sequence of introduction, product/market validation, business model valuation, and then growth. When a company becomes larger and more mature, there can and should be multiple stages occurring in parallel; this is especially true when introducing business models and associated products that purposefully evolve as they move the market. Exit can occur at any time in these sequences, though it is very rare for it to occur during Company / Product Launch. Nevertheless, some of the considerations of Exit should always be kept in mind. It’s worth noting that Exit defines the end of the process for one set of owners and investors, but the process continues with the new owners either where it left off, when the acquisition becomes an independent subsidiary, or as an extension of the parent company’s stages when integrated.
Figure 1: 6 Stages of Corporate Strategy from Concept to Exit
Startups evolving into growth stage companies are generally far better off establishing their launch product / service into the growth stage before taking on the New Product / Market extension cycle. That should not be viewed as an absolute rule; there are certainly cases where New Product / Market Extensions can be a critical part of building sufficient barriers to entry by competitors or in achieving the necessary market consumption transitions that occur as the market learns a new way of solving a problem.
By understanding the unique challenges of each of these stages, it becomes easier to understand the objectives, focus, and appropriate activities necessary to be successful. This understanding can prevent a very common problem for high growth companies: doing the right thing at the wrong time. Investing in product development before the target market and problem are well understood and the potential for building a viable business evaluated can introduce substantial risk of wasted resources and enterprise failure. Likewise, investing in sales and marketing expansion before the product / market fit is truly developed and understood and the basics of those processes are developed, will often result in high customer acquisition cost and the acquisition of a cadre of customers for whom the enterprise cannot deliver value. These customers will eventually churn resulting in lost revenue and confidence, the inability to raise capital, and a myriad of other negative enterprise killing effects. Similarly, pivoting to growth before the production and delivery processes are made sufficiently efficient, can drive substantial cash losses, and customer satisfaction issues with loss of reliability and effectivity in the delivery. The result, via a slightly different mechanism is the same. As a veteran of five successful turnarounds, I find clear causation of many turnarounds in failure to follow these stages in a logical and appropriate order.
It would be logical to ask how this process flow relates to the strategy development and execution processes laid out in my previous blog post. That post laid out a reference process to be followed on a periodic basis (development) and ongoing basis (execution). Within that process, there was a reference to the corporate development stage; this post relates directly to corporate development stage. In fact, that blog post outlined the process for a company in Product / Market Growth. For early-stage companies, the corporate development stage is on the spectrum of 1-2-3-4-6 (referring to the stages in Figure 1); later stage companies will include stage 5. As noted in that post, corporate development stage is critical to diving the appropriate focus of strategy development and execution. This post explains further how the process laid out in that blog post is tailored as a function of corporate development stage.
Once a company becomes mature enough to introduce product / market extensions, then the corporate development state is a blend of stages driven by the plurality of product and services within its portfolio and the maturity of each of those. I will write a deeper blog post on product portfolio management and product management to relate product to corporate strategy. In Figure 1, it may seem that there is no explicit strategic step for trimming the business and product portfolio. This very necessary step should be addressed explicitly as part of Product / Market Growth and is also a decision point in New Product / Market Extension, as well as both Product / Market and Business Model Validation.
Before discussing the six stages, it is important to discuss a key principle of entrepreneurial processes and agile management methodologies and contrast these concepts with more traditional management methods. Startups and even innovation efforts in larger companies are not small versions of larger companies; they are fundamentally different initiatives focused on the pursuit of a series of risk-focused discovery experiments that enable them to discover new business models. The reason for this is fundamental in psychology; we as humans tend to be far more effective at iterative convergence for solving complex problems versus big-bang solutions. Iterative convergence requires us to study the problem and propose an hypothesis for a solution and then test that hypothesis, using the results of that testing to drive another and another test, tuning or discarding and reinventing the hypothesis as we go until we finally converge on something that meets all of our requirements. For those you who think in agile development concepts, the only difference is that both the hypothesis and the requirements are converging in agile. The contrast is big bang, requiring that we study deeply the problem and then create a unified hypothesis that solves all the constraints and objectives and requirements. Big Bang tends to fail, sometimes spectacularly, due to fundamental psychological limitations of both the innovation team as well as the customers. To be successful, the team must fully capture the requirements, preferences, needs, deep pain points, and the tradeoffs between these facets for even a tight micro-niche of customers and this can generally requires an iterative process for discovery, in many cases, the customers don’t even know this data.
There are a class of products and services that appear to be successfully brought to market in big bang approaches; these are generally very complex engineering based solutions such as a Boeing 787 airliner, a geo-synchronous communications satellite such as the Boeing (formerly Hughes) HS702, or the Apple iPhone. However, this is an illusion. These products have complex customer requirements that must be discovered and substantially more complex engineering requirements to be discovered and satisfied through iterative, risk-based, R&D processes. The approaches I describe in my work are most on-point for businesses developed around software and services of all types. I will delve into a deeper future blog on the differences between manufactured product companies, pure service companies, and software product/service focused companies, as there are considerable interpretation differences and approaches.
Corporate value is created by experimental ideation discovery that identifies opportunity for true value and then through purposeful evolution of the solution to that opportunity to create predictable cash flow. Both steps are required, and they require different thinking that must co-exist in the same organization and leadership team. Those teams must be able to apply these different conceptual frameworks to stages and processes that may be occurring in parallel within the same company, meeting, or team. This need to embrace two very different ways of thinking is precisely why so many startups have difficulty accomplishing growth and predictability and so many established companies have so much difficulty invigorating innovation.
In the remainder of this blog post, I will explore some of the details of each of these stages including the objectives, key metrics, and some areas of consideration in how to develop and execute strategy in these stages. Specifically, I will explain how they differ in each stage from the conceptual model laid out in “Strategic Execution Part 2: Building and Executing Strategy”.
In the Company / Product Launch or Customer Development Stage, the company must come into existence, find its identity, identify a worthy problem to solve with an associated market, build an MVP, and find a repeatable business model. This stage must be driven by strategy and execution entirely different from the growth stage or what most people have experienced in stable-state companies.
Company / Product Launch (Customer Development) Objectives:
The objectives the Company / Product Launch Stage are:
Form the company and initial team and gather sufficient resources to keep the team going until next raise or sufficient revenue to support some salaries (often done iteratively).
Through an highly iterative process:
Focus the team on a problem domain and coalesce a mission, vision, and values as a step in determining the company’s identity.
Identify a worthy problem worth solving through investigation of the problem space, stakeholders, and current solutions.
Validate that problem through Customer Development interviews, discovery meetings, and research.
Develop a Minimum Viable Product (MVP) to address the problem and validate that MVP through traction metrics associated with a conceptualized target micro-niche market.
Transition into Product / Market Validation through a team acceptance / validation and/or a formal capital raise process for a Seed or Angel Round.
1. The problem, product, or service: problem has to be improvable / solvable and there is an envisioned way to improve the problem over its current state (the product / service).
2. Business model: solving the problem has to create value for someone who cares; the amount of value that can be created improving the problem will ultimately serve as a cap on the valuation of the company that will be created (or that portion of the company with products addressing that problem).
3. Business model: There has to be a connection between the value created and a payment mechanism or pathway to fund the business model and it should be feasible to refine the business model to profitability.
4. Business model: recurring revenue models where value is created and revenue harvested continuously build higher value and more sustainable companies.
5. Purpose: The problem and the people for whom you will solve it must resonate with the core team. It is hard to build a company and impossible if you do not truly care. Customers, employees, partners, and investors will see through the façade and eventually you will too.
6. MVP: I have observed a great deal of confusion over the MVP concept. It has come to mean multiple things to multiple people. In some cases, the MVP has taken on the reputation as being an extremely shoddy product that is hacked together and has almost no fitness for purpose. The truth is that the MVP is intended to be a simple version of the product, with low investment, that enables the customer to be exposed to and make a purchase decision on the fundamental value proposition being developed for the business model. Low investment and simple are subjective terms whose definition varies wildly by industry and problem domain. I will write a deeper blog post on some of the extremely wide variations in MVPs that I have seen and have proven viable.
7. Funding of companies is a market and sequential transaction driven business that is always evolving. There is a wide variety of models of capital investment. I have found the variation is most substantial at the earliest stage of the company; the terms Seed and Angel can be as interchangeable in this context.
Company / Product Launch (Customer Development) Key Metrics:
Two kinds of metrics matter in this stage. The first focuses on runway and the second on traction.
Runway always includes some cash but is primarily time in terms of how much time the founders are able to work without compensation to move through this stage and most of the subsequent stage of product / market fit. The cash is typically used to buy services and products to build MVPs, travel as needed, meet as needed, pay service providers as necessary, and for company infrastructure.
Traction is about addressing the principal risk of the enterprise which is product and market risk. This risk boils down to the fundamental question of whether or not the company is producing a product or service for which a market which will actually pay. The ultimate traction metric is revenue and recurring revenue is what really counts if institutional investors are the objective. Precursor traction metrics that are important would include conversion rates across the sales and delivery cycle(s) as well as cost baselines for successful conversions.
A third class of metrics is appropriate to start tracking at this point as well. They should not be the company’s primary focus during this stage, but will be in the subsequent stage and for that reason, it is important to start benchmarking. This 3rd set of metrics has to do with the closure rate of steps of uptake as well as the costs associated with accomplishing each of these steps. The uptake step model or customer funnel is unique to each business model, but all are similar to Figure 2. Some will call this the AARRR model (Acquisition, Activation, Retention, Revenue, and Referral). This model is merely a more generalized version and should enable an understanding of the need to tailor this model to the specific customer acquisition and retention process of the company.
Figure 2: Sample Uptake Step Model or Customer Funnel
Note that this is only one of many examples and the reason to start considering this model during Customer Development is that it forms the basis for proving the retirement of product / market risk. This is key to both external party fundraising as well as your confidence in the business. For this reason, base-lining these metrics during Customer Development and remembering the need to measure them during MVP development can accelerate the overall process by providing an objective comparison of the results of different business models / MVPs as well as demonstrating a focus on the necessary metrics when discussing the business with external stakeholders.
Company / Product Launch (Customer Development) Areas of Consideration:
I will not delve too deeply into the obvious facets of this stage, namely forming a company, drafting and filing the proper legal governance documents, and other basic items. These are important, but very objective and well documented; the focus here will be on the strategic aspects, namely the focus of the business and finding a repeatable business model.
Start with a problem space with which you are passionate; it helps greatly to have experience in the space, contacts, and an understanding of current industry dynamics. Form a small core team and start the process of Customer Development. The core team is obviously very important. There’s a great research based resource on this subject in the book The Founder’s Dilemma, by Dr. Noam Wasserman from USC / Marshall School of Business; he was at Harvard Business School when he wrote this book. Worth noting at this stage is the necessity to formalize the agreement between the founders with respect to contributions, generalized roles, intended focus, decision making process, and potential for departures. The initial phases of a startup will often involve periods of no or low income, confusion, and disillusionment. Founders should agree on the relative valuation of contributions of time and cash to the initial operation as well as the equity split, rules for how near-term additional contributions will be handled, how the enterprise will decide on existential pivots, and how founders’ equity will be handled upon the departure of a founder. The company should place all founder’s equity into a vesting program and file an 83(b) section election with the IRS to peg the basis of the vesting stock. These steps protect the business as well as the founders by predetermining the most contentious possible disputes as well as ensuring that the company can survive the departure of a founder. This IRS filing can save founders tens of thousands of dollars when they can least afford it and lower the overall tax bill on Exit.
There are a wide variety of methods to identify big problems to solve to build a company, they all must start with an identification of who you are and what you want to accomplish. Mission, Vision, Values is an appropriate start to this exercise. I specifically call out this activity at this stage for two reasons. First, it is critical to the process and second, at this stage, this step is most likely to need repeating and iteration, including possibly starting over. For this reason, it should not be overdone but it must be sufficient. In every other follow-on stage, the company will need this conceptual framework completed, but this is the only time it will start with a blank slate with the only exception to this being a possible future existential crisis or turnaround.
The next step is to identify a problem / problem domain. Mission, Vision, Values serves as a foundation for this step providing the backdrop of industry and desired impact. There are a wide variety of methods by which to perform this task. Here are a few that I have seen used:
· An existing process is observed as being flawed. This could be a personal / consumer process, buying, information processing, industrial process etc. and there are inefficiencies in that process that are driving higher cost, lower utilization, lower quality, or other compromises in use. There are literally millions of examples of this method. Web-based retail and wholesale of everything is an obvious class of examples.
· An existing solution / methodology has strong utilization, but you see an opportunity to radically transform those methods with technology. These can be big-bang companies; examples of this might include Microsoft and Apple with a mouse-driven user visual interface, Google with neural-network driven search and big data, Elon Musk’s collection of companies overturning industrial incumbents with significant technology driven leaps in battery storage, solar generation efficiency, chip processing speed and materials enabling reusable space launch, etc.
· A need is observed as unmet. In this case, a person has a need which could be personal or professional that is unmet in the current situation. A (not so recent) example of this might be in the innovation of reusing donor ligaments to rebuild orthopedic joints; the underlying problem of joint degeneration was unmet as millions of patients simply curtailed activity and dealt with the pain of the degeneration.
Iteration at this stage consists of identifying a possible problem / problem domain and performing Customer Development. The key at this stage is to identify potential customers, partners, suppliers, and other stakeholders around the problem and use widespread interviews and discovery conversations to develop a sufficiently deep understanding of the problem and problem domain to proceed. Who is who among the stakeholders should not be the focus, at least until the conversations unfold and patterns start to develop. This is iterative; the key is to identify a problem about which someone cares and an understanding of the facets of the problem.
Developing a business model is a process wherein a hypotheses of the product / service to address the problem is developed and the basics of how the product / service will be sold, delivered, and priced are conceptualized and validated (business model evaluation) against the basic criteria of this stage. Usage of a Lean Canvas is an excellent way to guide the discovery and development of this business model.
The business model is developed into the form of a Minimum Viable Product (MVP) or Minimum Viable Service (MVS) for validation. This step involves bringing something to market by which the viability of the problem / problem domain, business model, and product / service can be validated in the most objective way possible, uptake and revenue.
The core point to this process is to systematically identify a possible direction and then validate that direction in the best way available within the resource constraints of the business while also following a general to specific narrowing of scope. The intent of this approach is to recognize the substantial ratio of unknown to known, and minimize risk in the process by committing small increments of resources to each step (funds, time), while also validating each step to minimize missteps. The multiple return loops of iteration are there to acknowledge and account for the high likelihood of experiments that invalidate the entire pathway resulting in a return to start. Validation starts with the most general by focusing on deep conversations and design thinking associated with understanding an addressing the problem as well as understanding for whom solution would matter and progresses more specifically to a purchase decision.
There are a wide variety of approaches in terms of depth and pace that may be appropriate for each of these steps. These are guided by a variety of circumstances and experiences and the core risks of the business model. For example, the risks always involve customer identification and demand, but may also involve significant technical or regulatory risk as well as cost of low-volume manufacturing, and the specifics of the potential customer environment will likely dictate what is needed to validate traction. Each of these may drive hybridization of the process. I will address some of these variations as well as design thinking in future blog posts; there are also many great resources out there addressing these fundamentals.
The focus areas of this stage are rapidly hypothesizing and validating each element of the problem / domain / business model / MVP in order to arrive at a combination that is validated by a large and growing market, customer traction as demonstrated by actual revenue, and a business model whose functionality and economics have good reason to prove viable. Each step is often then followed by a change in direction and reformulation as the knowledge gained from each experiment is understood and incorporated.
If this stage will culminate in a funding round, sufficient attention must be paid to generating initial metrics around the uptake model as well as the fundamentals of Customer Acquisition Cost (CAC) and Lifetime Value (LTV). The expectation is not that these are well developed metrics but that they are benchmarked, understood, and that there is an understanding of how to move these metrics as needed in subsequent phases. As this blog is not focused on raising capital, I will focus more on fundraising at this stage in a future blog.
The key challenge of this stage are managing very scarce resources (money, time primarily) with the potentially unbounded task of identifying a viable problem / business model / MVP. The best approaches to this are to establish the core team and a pool of financial resources that team is willing to expend to reach that stage, measurable in time and cash to spend. That core team should focus on thoughtful but rapid iteration through the model explained above; working to ensure that each cycle is given enough attention to trust the lesson it teaches while remaining focused on speed. Keeping teams on track about the key decision of tune vs. abandon and rethink are more important than keeping to an experiments/week type of productivity schedule, though I have seen teams track that level of productivity simply to understand if their cycles are accelerating or slowing and the possible implications to quality.
When the team has met the following criteria then the Product / Market is defined and it is time for Product / Market Validation:
Produced a business model with a product / service value proposition and a way to monetize that value
Market proof of uptake of an MVP of that model
The team has conceptualized the evolution of the business model, delivery methods, development methods, go-to-market methods, assessed competition, and evaluated the evolution of the company and product without seeing insurmountable hurdles
This is obviously subjective and is primarily validated by the team and their advisors. If a capital raise is involved, then there is an additional validation point. CEO’s would do well to remember, however, that transitioning to Product / Market Validation and raising an Angel or Seed round are not necessarily tied to each other.
In the Product / Market Validation phase, the company must perform a series of experiments and growth exercises to validate the product or service and target market identified in the Company / Product Launch or Customer Development Stage. That validation involves a product and/or service that bears paying, sustainable customers within a defined market micro-niche with an established value proposition including pricing. The real focus of this stage is exploration and deep understanding of the market and the way the product / service developed in the previous stage really creates value. While growth during this stage will be important for financial reasons, the primary purpose of growth will be to fuel a series of evolving experiments to enable that deep understanding.
Product / Market Validation Objectives:
Through iterative, narrowing experimentation develop a deep understanding of the primary 3 factors of product / market fit:
Feature / facet mapping of driver(s) of value within the market space. This is an exploration of what features drive what kind of value for customers
Market / Value mapping identifying the dimension(s) of the market as they relate to the product / service value production, an exploration of how the drivers of value vary across the market space and in which niches is the value realizable or not and why
Operational driver(s) for value capture for the company; the % of value captured in revenue for the company of value produced for a company, this should include pricing
Achieve a proof of Product / Market Fit through development of a customer base, with controlled churn, and consistent recurring and one-time revenue with industry / business model appropriate gross margin.
Develop initial Sales, Development, Delivery, and Operations models and baseline their efficacy and efficiency.
Stand up basic management to budget and team structure, if not already developed in Company / Product Launch.
Product / Market Validation Key Metrics:
The metrics of each stage build on previous stages. Runway, through cash and time management of the team remain a key metric as do the traction metrics of revenue as well the metrics associated with the uptake step model shown in Figure 2. Added to this set of metrics are a few additional key metrics:
Product Cohort / Complete Customer base churn. This metric is the primary indicator or proof of product / market fit. Appropriate churn rates vary by size, maturity, product price, customer type and a myriad other factors. In the venture world, companies need to target 5-7% annual churn by the time they reach approximately $10M in annual revenue, but rates as high as 40% annual churn would still support a conclusion of product / market fit when the annual revenue is still below $1M. Of course, these figures vary as a function of the free-flow of capital and the specific company / investor.
Customer Value versus Pricing. This set of metrics enables an understanding of the value created for the customer through use of the product or service and should include a mapping of key drivers in that value proposition. Not all products / services will support a metric of this nature.
Gross Margin and unit economics for the company; this would include Research and Development (R&D), Sales and Marketing (S&M), and General and Administrative (G&A) as a % of revenue. This set of metrics enables an understanding of the value capture as well as the relative expenditure base of the company. Benchmarks for appropriate values vary significantly for different types of companies, but this data does exist and is useful for targeting these expenditure levels. For most companies, Gross Margin of at least 60% is appropriate; recognizing that for many SaaS companies, Gross Margins above 90% are realistic and appropriate.
Customer Acquisition Cost (CAC) and Life-Time Value (LTV) should also be tracked at this stage, but primarily to identify a benchmark for Business Model Validation as well as to enable a deeper analysis of process and tools drivers of both.
Product / Market Validation Areas of Consideration:
Performing Product / Market Validation requires coherent orchestration of a series of experiments the company must perform. Synchronicity of effort across the enterprise is critical. These experiments must be designed to reveal a mapping of the market space, the product and associated perceived value of features associated with sub-segments of the market, and the customer sensitivity to pricing. Mapping should not be construed to imply that the entire feature-market space is mapped; the process should be convergent with additional mapping performed in other stages. In most cases, this process will reveal a shallow map of most but not all of the space, with value-feature depth in select areas, but most especially in the target micro-niche. Once this mapping is achieved, the focus should pivot to building the revenue base in an identified attractive sub-segment of the market and baselining and refining the sales, marketing, development, delivery, operation, and support of the product.
Market mapping begins with the first question of what drives the market dimensionality. There can be multiple dimensions to a market; these typically are demographic based measures but can mix multiple types such as size, revenue, industry focus, growth stage, supply chain stage, etc. for B2B companies. For B2C companies, these dimensions might be age, income, educational status, homeowner status, hobby interests, professional interests, or many others. For most companies, their market is truly segment-able with only one or two dimensions. There can be layers to the segmentation as well; the first layer might be filters that exclude obvious non-customers; the intent here is to identify dimensions that support mapping of a broad market population.
Once market dimensionality is identified, the value proposition should be vetted across the dimension by attempted sales and customer relationship building, interviews, surveys, and analysis. This should reveal a deeper understanding of how the MVP, as it evolves, is viewed by potential and actual customers at various points along the primary market dimensions. As this understanding is gained, two things will happen. First, the market mapping will become clearer, and second the capabilities and features appropriate to augment the MVP will become clearer and that clarity should drive continued product development. The market mapping is a primary objective. This map will drive continued coherent product development, sales expansion, investment, and many other facets of the growth of the company.
It is imperative that these exercises yield more than a binary good / bad mapping of value perception across the market. The real value here is in the why. Why customers and prospects perceive things differently needs to be understood in order to drive continued product development, separate the perceived product value from the process of measuring, and identify potential roadblocks to future sales and growth. The key skill here is business development; a pure sales approach will miss the mark and waste a lot of resources especially time, market good will, and cash. The difference is the focus on understanding vs. making the sale.
The market mapping exercise can drive a pivot back to early-stage Customer Development. If the initial work appears to be invalidated by the mapping, where the market does not perceive value broadly and there is not a clear path to repairing that situation, or where the resultant mapped market appears too small and/or not growing, then a major pivot may be in order. Smaller pivots are more common, in fact expected, where the exercise has to alter the fundamentals of the MVP to complete the mapping.
Once the market mapping is performed, a target micro-niche is identified, and a deep understanding of the value proposition and how it needs to evolve is developed for that identified micro-niche; then the focus now shifts to proving product / market fit. To do this, the company needs to focus the continued experimentation on the target micro-niche. Here the focus shifts to understanding the perceived value of the product within that micro-niche and performing experiments with pricing. Performance guarantees, to the extent that they are required will play into this and can extend the proof cycle often driving the time to equal 1-2 performance guarantee cycles. Pricing analysis and sensitivity analysis should be performed to gain an understanding of the impact of pricing on initial sales as well as churn. With pricing understood it is time to benchmark the company’s internal value chain with gross margin, R&D/revenue, S&M/revenue, G&A/revenue, as well as the more targeted metrics of Customer Acquisition Cost (CAC) and Life-Time Value (LTV). Along with these metrics, should come an analysis of the internal processes that have organically developed within the company for all of these functions and opportunities to alter and improve the cost and speed of those processes.
The criteria for having achieved product / market fit are a function of industry, capital sources and associated perspectives, and market conditions. The point of the milestone is to objectively state that the company has a product that a market is repeatedly buying and not returning (or is recurrently buying), that the product is commanding sufficient value and associated pricing to be able to support the company with reasonable outside capital to offset growth and process inefficiency, and that the company has benchmarked and assessed the next phase. For many high growth companies, this milestone will be marked with the first institutional outside investment and that will help define the objectivity of the milestone. For those not raising capital, this milestone requires an objective assessment of the stability of the growing customer base, the revenue stream’s ability to support growth in expenditures associated with streamlining the company, and a confidence that it’s time to invest in that streamlining along with what is usually a steeper proof point; sufficient free cash flow to invest in growth.
The purpose of the Business Model Validation stage is to tune the company and all the processes and core product to set the stage for growth. The previous stages have brought the company to having a product and market micro-niche match in which to sell, with repeatable and scalable revenue, and reasonable customer churn. Without this, the company is a business, but without being able to do all of this without generating sufficient profit to fuel future growth, development, and eventual capital returns, that business is not sustainable. The purpose of Business Model Validation is to update the product and processes associated with that product to a state where the value created for customers and captured by the company can support continued growth. It is at this point, where the company should start being managed by processes more resembling a growth stage company, as referenced in the beginning of this post. The process is to execute micro-niche focused growth and product development, while also performing a series of internal process transformations and associated automation.
Business Model Validation Objectives:
Continued growth and servicing of the customer base, development of the product and sustainment or improvement of pricing and churn rates.
Stand up marketing and sales processes including marketing channels, ideal customer criteria, messaging, toolsets, and content, also including solidification of testimonials and other proof of performance, and finally a sales funnel process and associated collateral, proposal material, and digital tools that may facilitate these processes.
Continue to mature and benchmark as necessary the product management, product development, delivery, integration, training, support, and retirement / closeout processes including all services that touch the customer.
Stand up and evolve internal productivity measures for all organizations and processes.
Step maturation in corporate support processes such as HR, finance, compliance, etc.
Achieve an industry / business / investor appropriate ratio of LTV to CAC as a measure of the company’s success in refining the value produced and captured to support growth.
Usually, a step maturation in governance processes is appropriate and required with the addition of institutional investment.
Business Model Validation Metrics:
The metrics of each stage build on previous stages. Runway, through cash and time management of the team remain a key metric as do the traction metrics of revenue as well the metrics associated with the uptake step model shown in Figure 2. The metrics added in Product / Market Validation remain important including Product Cohort / Complete Customer base churn, Customer Value versus Pricing, Gross Margin and unit economics for the company, Customer Acquisition Cost (CAC) and Life-Time Value (LTV). The company should start tracking the ratio of LTV to CAC. All of the above metrics now solidify as the primary corporate-wide metrics, from which the company’s true Key Performance Indictors (KPI) should be selected (or Key Results Indicator, as appropriate). Added to this set of metrics are metrics that will be highly dependent on the organizational structure and the inherent functional process design of the company. These metrics are time, cost, productivity, and quality measures associated with all of the organizations and other key processes in the company.
Business Model Validation Areas of Consideration:
Business Model Validation is the most ignored stage of corporate development in startup companies. We are all products of our experiences, and there are a class of companies out there (e-Commerce, SaaS primarily) that stand a strong chance of arriving at the end of Product/Market Fit with their unit economics in order. The reason for this is that many of their externally facing and internal processes are inherently software based and efficient to begin with. Another way to look at this is that any efficiencies are generally exposed to the customer and thus take on greater urgency in earlier stages. In either event, failure to perform this stage can doom your company to being an inefficient capital-sucking beast that is not scalable. At minimum, all companies should treat this stage as a criteria-driven non-optional stage that may be performed very quickly.
At this stage, companies tend to start being run as growth stage companies from a strategic planning and execution perspective. Cyclical strategic planning with purposeful strategic projects and continued product experimentation (referenced as product mapping in the Product / Market Validation Stage) are the focus. The projects should be a mix of process standup and improvement across the entire organization. The process should be iterative and prioritized by internal process interdependencies. ROI as a strategic management tool to prioritize initiatives becomes important once the company enters the Product / Market Growth stage. This should be introduced at this stage as part but not all of the priority criteria. Depending on the state of corporate processes, however, ROI may or may not be most important as a measure as some processes and tool introductions are simply not optional and ROI calculations may not be particularly reliable.
There are five (5) key focus areas that start to become important during this stage:
Continued Product / Market refinement
Customer Acquisition Process
Value Delivery Processes including retention
Talent development and retention
Management and Governance
The continued evolution of the product and the understanding of which market niches to which to target the product is an ongoing key focus area from this point forward. This should always include evaluation of the ongoing viability of the product within its targeted market niche. As noted before, I will write a deeper blog post on product and product portfolio management to address the nuances of this process.
Customer acquisition processes include ongoing market sub-niche exploration, demand generation, prospecting, sales, portions of onboarding, and portions of retention among possibly others unique to your product and company. This stage is the first point at which it makes sense to develop a formal sales team, as well as territories or market niches or other means of managing sales conflict. The marketing team should have been seeded during the Product / Market Validation stage, and expanded during this stage. There is a well-proven adage that marketing scale up should proceed sales scale-up so market demand is in place before the sales team attacks that demand. It is also worth recognizing that the marketing team and a seeded sales team are required to develop the prototype sales processes along with the business development team (usually the CEO or other key founder). A part of this process is ensuring a well-developed target customer profile to guide the marketing and sales activity. Another part is building at least a preliminary sales playbook. The company needs to continue to measure Customer Acquisition Cost (CAC) on a unit basis and introduce marketing channel and message refinements, process streamlining, target customer focus, proof of performance, and canned support material as well as automation to start reducing that cost.
Value delivery processes include product development and deployment, portions of onboarding, usage processes, maintenance and support, training, and portions of retention activities among possibly others unique to your product and company. I note onboarding and retention processes as split between customer acquisition and value delivery because there are a variety of process models for performing these functions. There usually is some point in the process there is clearly a transition or subtasks that clearly are one or the other. In most companies I have seen, the processes to perform the value delivery chain are purposeful ad-hocs and hacks designed to get the job done without the development that was not previously affordable or are manual processes that the original team could not spend the focus on automating. The company needs to continue to measure the Lifetime Value (LTV) on a unit basis and introduce process refinements, reformulations, automation, customer and employee training, data libraries and models, and myriad other steps to ensure the customer is receiving the intended value and the company’s cost to deliver that value is appropriately constrained. LTV is a function of value capture per unit per time-period x the number of time-periods a customer may be expected to be retained once on boarded. Delivering value and retaining customers is a key facet of this focus area and should be the first focus of the company. Process efficiency can take a back seat to customer retention, with the tradeoff that to the extent this occurs, the longer this stage will take.
An additional key point is worth making here with regard to the company’s customer base and churn rate as well as LTV. For most companies, as customers as been acquired, the product has also evolved. The product / market experimentation of the Product / Market Validation and Business Model Validation stages may have resulted in customers on boarded for whom the product is not a tremendous fit. These facts can set the company up for future churn, and will likely distort the value of the LTV calculation. Contracts that include longer periods of performance and/or performance guarantees can amplify this skewing. If the product is a SaaS product or the company has another mechanism for synchronizing product in the field, this can address these inconsistencies; for that reason, such mechanisms are strongly encouraged. Non-fit customers can be a larger problem. At minimum, the company should ensure sales into this sub-niche are deceased, the LTV and churn metrics isolated, and internal and external stakeholders informed. In addition to this, the company must choose what to do with these customers; the cost of retention can vary. In some cases, the industry reputational damage and temptation to compromise the value proposition with collateral effects is too great and relationships with these customers terminated. In other cases, the relationship can be used as an opportunity to tune the product to repair the value delivery. Finally, in some cases, the right thing to do is to let the non-fits customers languish and determine their own outcome. These options can be present within the same company / situation and the right decision dependent upon the customer. The situation should serve as a good reminder to practice good product / market hygiene as experiments are concluded.
Customer Acquisition and Value Delivery must be refined in concert with each other. First, together they typically define the entire customer journey with the company and must be holistically tied to each other if the objective is to optimize that experience; and it should be. Second, it is possible that a change in one-area effects the other with regard to information collection, prospect filtering, and even market sub-niche focus.
I will not focus too much on talent development and retention, despite its tremendous importance, as it is an appropriate topic for a future blog-post. The Business Model Validation stage is typically the point where the company will start expanding beyond the founders and their surrounding set of core employees. It is often the turning point where a number of changes happen:
The trade of equity options vs. salary becomes less of a core incentive element
New employees become less jack of all trades and more specialized requiring structure, evaluation, measurement, and more employee-specific HR management
Key core employees, and founders, will start to see their jobs start morphing, often quite rapidly with introduction of management responsibilities, planning, and other skillsets they may not have
All of these changes require an evolution in the way the company attracts, manages, retains, and off-boards employees.
The company usually requires a step-change in professionalization of the management and governance processes. The teams are generally starting to become large enough where there are layers of communication, coordination, and tactical / strategic intent. Further, both employees and external stakeholders will start demanding a higher degree of planning and performance to plan.
The exit criteria for Business Model Validation can include many different factors, but the ratio of LTV to CAC is emerging as a leading indicator of readiness for transitioning into the Product / Market Growth stage. This ratio can best be thought of as the ROI for growing the business. It expresses the expected dollar margin contribution to the company for an investment of a dollar in customer acquisition activity. There are a variety of opinions out there about what this ratio must reach; the most common opinion I have seen for venture-backed companies is 3:1 as a transition threshold; much of the empirical basis of this ratio comes from venture backed SaaS companies with a relatively low process refinement cost and good capital reserves. However, it’s worth understanding that this ratio should continue to grow as the work of refining this ratio continues in Product / Market Growth and for companies that require either greater investment in process transformation or perhaps have smaller capital reserves (in house and in investor dry powder), a ratio higher than 3:1 may be wise. Secondary indicators should also be validated including the presence of known product / market fit issues, sales obstacles, and insufficient team skills or structure.
The purpose of the Product / Market Growth stage is to scale the company and business model associated with a product / service within the overall product portfolio. This is the stage that most people associate with scaling, and the methods of strategic planning and execution outlined in my blog post now become entirely appropriate. This stage will serve as the primary stage of growth and operations of the company from which to launch New Product / Market Extensions or transition into Exit.
Product / Market Growth Objectives:
Leveraging and building the sales force, sales channels, and revenue growth paths; continued growth and servicing of the customer base, development of the product and sustainment or improvement of pricing and churn rates.
Continue maturation of customer acquisition and value delivery processes for greater efficacy, efficiency, and value creation.
Continued maturation of the product management processes to ensure the product / service line being grown continues to evolve and meet the needs of the targeted market as well as to identify extension opportunities that will be addressed in New Product / Market Extensions.
Continue maturation of corporate processes such as HR, finance, compliance, and governance.
Product / Market Growth Key Metrics:
The metrics of each stage build on previous stages. Runway, through cash and time management of the team remain a key metric as do the traction metrics of revenue as well the metrics associated with the uptake step model shown in Figure 2. The metrics added in Product / Market Validation remain important including Product Cohort / Complete Customer base churn, Customer Value versus Pricing, Gross Margin and unit economics for the company, Customer Acquisition Cost (CAC) and Life-Time Value (LTV) along with their ratios. The company should now start tracking over to top line KPIs (Key Performance Indicators) at a top level with flow down through the organization to PIs (Performance Indicators). These KPIs and PIs should be tuned to the investment horizon, growth, and Exit horizon and culture objectives. These metric are best developed for each company based on the focus on revenue growth or profit growth, along with other top line objectives the company may have.
Product / Market Growth Areas of Consideration:
Cyclical strategic planning with purposeful development of the sales, marketing, and delivery functions, purposeful strategic projects along with continued product experimentation are the focus. The company can and should now be run in a much more managed and mature way with a gradual expansion of the management team to cover more and more functions with specialists rather than the 3 to 10 hat / single executive approach before this stage. Coherency of thought and action in the executive and management team will become more challenging and become more critical. Projects across the enterprise should be performed primarily in concert with continued product elaboration, process refinement and automation, and market and channel expansion. Six (6) key focus areas that start to become important during this stage:
Continued Product / Market refinement
Customer Acquisition Process scale growth, refinement, and market / channel expansion
Value Delivery Processes growth and refinement
Talent development and retention
Management and Governance
Triggering the New Product / Market Extension Stages
Many of these focus areas are the same as during the Business Model Validation stage, with a shifted strategic set of objectives related to growth KPIs. It should be noted that many companies shift their focus to revenue and possibly EBITDA growth during this stage as their top KPI. There are strong benefits to the kind of focus that comes from 1-2 KPI management focus. However, a key assumption should always be understood and expressed. Which is that the other performance indicators, such as churn, customer satisfaction, employee satisfaction, Gross Margin, and many others once brought to the growth level of maturity are to be retained during this focus. Any substantial changes in these metrics, even while hitting top-line revenue objectives can be as detrimental, perhaps even more so, than missing the top line objectives.
The primary focus on customer acquisition process is in making the process bigger, faster, and more effective. This includes the challenge of building the marketing footprint and effectivity, growing sales teams, expanding territories, identifying new sales channels, and refining ideal customer targeting, collateral resources, proof of performance, customer onboarding, and other tools and resources required to drive customer acquisition. As a result, the organizations performing these tasks must become larger, more distributed, and require a greater formality of management.
The Management and Governance processes need to evolve significantly during this stage; this should be an iterative process. The team will get larger and then much larger making communication, values coherency, and coherency of action more challenging. Further, for institutionally backed companies, this stage will often see the introduction of multiple new rounds of investors focused on later stage investments who may each demand a higher degree of rigor in governance. The board should have committees during this stage for audit and compensation at minimum; many will have additional committees that may be focused on talent pipeline, succession planning, acquisition identification and vetting, or to address special risks or opportunities. During this stage, identifying Exit timing, market conditions, and potential Exit paths should become an additional focus area of the board.
Product / Market pruning is an important part of product portfolio management during the Product / Market Growth stage. Pruning is the act of recognizing industry evolution, competitive landscape changes, and shifts in preferences that should result in the purposeful retirement of products and services either in the form of transition to another product or service or through end-of-life termination. This could be confused with the need to manage the product/service deployment versioning footprint to reign in support costs, prevent compatibility issues, and retain high customer satisfaction; I view that as part of both stages 3 and 4. Pruning refers to purposeful product / service / market retirement to avoid financial loss and/or reputational damage.
Triggering the New Product / Market Extension stages is a critical focus area for achieving true rapid growth. A strong product management function, well integrated into the revenue, operations, and finance organizations, and tightly tied to corporate strategy creation and execution is critical to performing this task. There are four fundamental levers for growth of the company that should be routinely assessed and prioritized as part of the strategic planning and execution process:
Market Penetration is fundamentally sales growth; this is the core focus of the growth stage from the customer acquisition and value delivery arms of the company. Value penetration is the systematic identification of product / service features and facets that can be introduced that enhance the customer perception of the value of the product / service, throw up barriers to entry of competitors, and that may also enhance value capture through pricing and other fundamental business terms.
Adjacent and Peripheral Markets and Value Extensions are opportunities the product management team should be developing to introduce new product / service lines, adjacent products or services, and potentially new markets. This process should be looking at product / market as a coherent set. Product / Market Pivots are entirely new product / service lines not tied to existing products and services or Market extensions for existing products that require product extension. In general, companies should not consider introducing completely unrelated products and services to completely unrelated markets; the resulting market and internal confusion can be substantial. How tightly tied new should be to old is a function of the company’s market identity, internal capabilities, and state of affairs. In general, it is best to drive New Product / Market Extensions based on their correlation with the existing portfolio of products, services, and markets for a wide variety of reasons.
Most initiatives triggered in this focus area will be for products and services that have some adjacency to the existing products and services. An example might help: A company finds that their system management software for industrial processes is, with some customers, managing a component that requires faster cycle times, no manual intervention, and custom-programmed responses; they identify a product at a different level of abstraction in their customer’s system and then identify a different and larger market that requires this new software. Their technical teams can produce it and the product can be delivered at reasonable profit; the new product opens a larger market to evaluate for their system management software. The new adjacent product is a go.
Another example might be the pursuit of an adjacent market. During Product / Market Validation, the product feature/market mapping exercise identified a large higher-end market segment that can only be addressed with the addition of expensive features that would not be appealing to the originally addressed lower-end market. These new features justify a new pricing point and entirely new product, marketing, sales, and delivery processes that have some overlap with the existing processes. This great market extension drives an entirely new product or a new level of the product with unique pricing and positioning. The possibility of expanding into new geographic markets is also an obvious extension.
Product / Market Pivots can be the most challenging to identify; these are entirely distinct product / market entries whose only relation may be that they address market disruption from technology advancements, new entrants, regulatory or other environmental changes, or a wide variety of other causes. They are usually, but now always, for the same market the company has been addressing. Such pivots tend to be existential bets for the company; the great challenge is that in the Growth stage, efficiency and predictability must be gained by a degree of process bureaucratization that focuses thinking away from disruption. For this reason, the executive team and board must take the time to build a scan of the environment and maintain awareness of trends into their strategic planning processes. For many companies, even this additional set of steps can be insufficient due to perceptive normalization biases of key employees and executives. This is one reason among many that objective outside facilitators can be critical to a successful strategic planning process. In times of industry turmoil and rapid transition, some companies will additionally create an outside “skunk works” to identify, evaluate, and respond to create the effect of the company disrupting themselves before a competitor does. The structure, culture, and incentives associated with such efforts are critical to their serving their core purpose rather than being a tremendous boondoggle.
All New Product / Market Extensions identified and vetted as appropriate to pursue should trigger an entry into an adjacent New Product / Market Extension Stage and cycle while the Growth stage continues forward. Once this new cycle reaches Growth Stage, it is commonly melded back into the mainstream growth stage with any unique facets of ongoing product management, customer acquisition, and value delivery spurring unique processes within the company; with recognition of the efficiencies and potential downsides of reintegration vs. not.
As previously noted, I will defer to a future blog post the details of product and product portfolio management including appropriate vetting processes and culture to spur and vet innovation.
The New Product / Market Extension stage will actually spur a repeat of several previous stages with a specific focus on the New Product / Market. The company will take a New Product / Market Extension concept and either bring it to reality, pivot it, or kill it. This stage generally shouldn’t be activated until the company has entered Product / Market Growth with its primary product portfolio and also established a process to identify and initially vet the New Product / Market Extensions; a common approach here is to implement a stage-gate maturation process to determine whether and which opportunities to purse. With more agile management methodologies, the iterative facets of the approach can be built into the New Product / Market Extension and integrated with the over-arching strategic assessment process as will be explained below.
The specific New Product / Market Extension process is most akin to the Company Launch (Customer Development activities). The differences are that the company doesn’t need to form and the runway management processes are based on established budgets and resource allocations from the company, the pivot-to product / market may be defined by the overarching strategic assessment process, and whatever product / market / operational coherencies with the company’s existing product portfolio is levied on the team as a requirement. These differences must be carefully applied in order to maintain the innovation capacity of the company; teams perform very differently when they are making a personal bet of their resources and livelihoods on the success of an endeavor versus when they are taking home a comfortable paycheck.
As with the core Company Launch stage, the same criteria can be applied to graduating a product / market match to a version of Product / Market Validation.
The version of Product / Market Validation for a Product / Market Extension should be very similar to the core Product / Market Validation. The exceptions are the same as when comparing the New Product / Market Extension stage to the Company Launch Stage. The exit criteria for entering a version of the Business Model Validation stage for the new product / market set are the same as a core Product / Market Validation Stage.
The version of Business Model Validation for the new product / market set should be very similar to the core Business Model Validation stage, the exceptions have already been noted though in this stage; whatever product / market / operational coherencies with the company’s existing product portfolio that were levied as requirements will start coming to fruition and operation during this stage. The exit criteria for this stage are the same as for the core Business Model Validation Stage.
Once the new Product / Market set is graduated into Product / Market Growth it is introduced into the operational product / service portfolio and subject to its own growth maturation efforts. The degree to which the new is integrated with the old will vary across operating models; there is obviously an efficiency opportunity in deeper integration, but there is also the risk of product / service homogenization and unproductive compromises in value delivery and market perception. It is generally important to recognize that the market penetration and growth curves will be different and the product / service should be managed independently within the portfolio.
There are many potential pitfalls to this facet of executing growth, one of the greatest is failing to recognize the important difference between sales and business development, and that the introduction of sales must be deferred until later Business Model Validation. As before, the reason for this is that sales has the mindset and incentives to turn the crank on selling existing product to identified market with the lead generation engine (marketing) up and running. Business Development is about the type of market and value proposition mapping, experimentation, and product / service realization required to perform the first three stages. Mixing the two up results in very frustrated people, missed goals, and product / service development chasing ever-changing preferences and requirements.
The Exit stage is the stages during which the founders, investors, and stakeholders along the way will harvest the value they have helped build over the life of the company. It is also, often, the beginning of a new life for the company with new direction, resources, and capital. This stage consists of preparation, the transaction, integration, and post-merger operations. The objectives should be tailored to the goals and interests of the founders and subsequent stakeholder investors. In most cases, maximizing value extracted is the key objective; other considerations may include the landing for key people and teams that the founder has built, as well as perpetuation of brand and reputation. The most important thing to remember for founders is that Exit looks very different for founders and investors for two key reasons. The first is that most Exit transactions tie founder’s equity to the successful integration and post-merger operation and the second is that, depending upon how the company’s value has been built, investors often have liquidation preferences and other terms that may divide the company’s value unequally.
The first thing to note is that the objectives of Exit are not always the same:
Maximize the value received for the business both through the transaction and as founder’s value is actually extracted (most common)
Create a career transition for founder’s and key personnel into the new business (possible)
Protect the teams and people who helped build the business (possible)
Protect the legacy of what has been built (possible)
Exit Key Metrics:
Key Metrics for Exit varies by sub-phase.
During the preparation and into the transaction phase, the key metrics are the growth stage KPIs the company has been using, with specific attention to hitting predictable growth, profitability, churn, and free cash flow. Maximizing the value obtained for the company.
During the integration phase, the key metrics will relate to the objectives of the integration plan. These usually relate to key personnel retention, intellectual property security, avoiding process disruption, and customer relationship management.
Once the post-merger operations begin, the key metrics will transition over to the KPIs for the new strategic plan, whether for the new independent entity or the entity as integrated and now a part of the strategic plan for the larger organization.
Exit Areas of Consideration:
Exit should be viewed as a stage rather than as an event; it is a sequence of changes and actions. For founders and other key personnel, it can last for many years or be shorter. Looking at each of the elements of the stage independently of preparation, the transaction, integration, and post-merger operations, I will share some areas of consideration for each of the elements.
It makes sense to perform a brief review of the Exit pathways that exist for most privately held companies:
Initial Public Offering (IPO): Here, the stock of the company is offered in the public markets and the company will continue as a public entity. Sarbanes Oxley and other regulations have made this option less attractive in the last decade for most private companies, but there are circumstances where it is the right answer. The value of the company is determined primarily by its financial performance and potential along with public market perceptions and trends.
Financial Holding Company: Here, the stock of the company is acquired by a financial holding company for continued operation and generally will not be integrated, though management and growth practices may be levied down to the company’s management. The value of the company is determined primarily by its financial performance and potential.
Strategic Acquirer: Here the stock of the company is acquired by an operational company that sells products and/or services purchases the stock of the company in order to integrate operations (generally), product, and service offerings. The value of the company will be determined by a combination of its financial performance and potential and its perceived upside potential to enhancing the financial performance of the acquirer.
Private Equity Acquirer: here a private-equity backed operational company and team that are pursuing a well-defined investment thesis acquire the stock of the company. The acquisition may be viewed either as a platform or as a strategic add-on. In the former, the value of the company is determined by its financial performance and potential, specifically its ability to carry strong debt leverage through EBITDA production and operationally perform as a platform for augmentation to fulfill the investment thesis. As a strategic add-on, the value will primarily be determined by a combination of the financial performance and potential as well as a heavy emphasis on the potential to improve the financial performance of the platform company.
Asset sale: Here the company will be broken up with specific assets sold to potentially different acquirers. This can be a part of one other types of Exits to shed risk-bearing or non-critical assets, or it could be the only opportunity for liquidation given poor performance of the operations of the company. In the latter case, the company may be wound down after a sufficient number of assets are sold. The remainder of this section will focus on Exit as a sale of the equity.
Planning for Exit should really begin during Company Launch and constantly updated and revisited during the life of the company. The key activity to focus on as Exit timing draws near has to do with operational consistency and identifying the best transaction opportunities. Operational consistency is important because the ultimate value derived for the business is always dependent, at least in part, on the free cash flow being produced by the business (whether turned into growth, used to improve the business, or accumulated as cash) including the reliability of that cash flow. How that free cash flow should be purposed prior to Exit varies by industry, company type, and market conditions. There are circumstances where the best value comes from driving growth and producing zero or negative EBITDA right up to the transaction and there are conditions where that would be entirely inappropriate. Looking at industry trends, financial markets, and speaking to a variety of potential acquirers in the early stages can help vet out which type of transaction is best for and most likely for the company. The mechanics of preparation should be obvious. As with each capital raise, the transaction will be accelerated by having a data room ready to support acquirer’s due diligence before the first serious discussion. Just like with each capital raise, the executive team and board should review the enterprise’s risks and issues and resolve where appropriate, independent of the decision to acquire reps and warranties insurance.
I will not delve into the transaction itself in detail, as there are number of good resources on negotiation preparation, vetting potential business partners, and game theory in conducting the negotiation itself. These are likely appropriate for preparing for any capital raise as well. There are a number of important points for managing the company during the transaction itself that are worth pointing out. First, keep running the company and keep the transaction and daily operations separate. It is critical for a CEO to build a management team around them that can run the company without much intervention from the CEO to make this work. The CEO and CFO will be most involved, with select top executives involved as needed. Ensure secrecy of the transaction is maintained, but be ready to address the transaction being leaked to employees, suppliers, and customers as this may happen. Ensure that a rapid integration plan is prepared that addresses key personnel retention, IP protection, business continuity through the integration, relationship retention, and any other key items specific to the integration.
When the day comes for the acquisition announcement kickoff of the integration, the most important thing to remember is that large number of participants in the process may be stunned into inaction; including possibly yourself and other members of the executive team. The first thing to address is always the personal and the key is to be able to address how this change affects each person recognizing that such change always breeds a great deal of fear. Good planning and attention to taking care of people to a reasonable degree makes this possible, but must be followed by swift action. Integration of operations, processes, systems, and daily activity can and should proceed on an orderly plan after that. Settling the key issues of people, relationships, and IP first will build a foundation that enables the team to focus. I will write a separate future blog post on M&A integration and other facets of M&A.
Post-Merger Operation is the period during which founders may find themselves in operational / management roles within the new entity that resulted from the acquisition. This period may last through the completion of the integration or beyond. It is common for stock from the acquired company to be converted to stock of the acquiring company and for additional stock transactions to be restricted for some period. In some cases, it may also be desirable for the acquiring company and one or more of the founders or key personnel to maintain their role into the future. In either event, these minimum holding and operations periods are there to ensure that the value purchased is retained to the extent possible through careful shepherding of the integration and operations, that the new executive team learns what is needed about the new company, and that any risks, misrepresentations, and issues are identified and settled as appropriate.
What stage of corporate development are you currently in and what challenges are you facing?
For most companies, the usage of external parties to facilitate the strategic planning and execution process produces superior results. The process typically involves a great deal of information processing that isn’t core to running the business on a daily basis and a facilitator in planning sessions frees up the team to focus on the critical questions rather than the process and can inject highly productive objectivity into the discussion and decisions. If you would like to discuss where your company is in the evolution of strategic planning and execution or would like some assistance in setting up or performing this critical process or just have a question please contact us.