VC Cliche of the Week

This is not a cliche but a great line that I heard several weeks ago that I have been using since (so it may become a cliche):

If you must forecast, do it often.

Forecasting is always a difficult proposition and loaded with risks for the person doing the forecasting.

We ask each of our companies to go through a budget process at year end (right now) and set the goals for the following year.  That is essentially a forecasting exercise (on the top line at least).

And many of our companies have incentive comp plans (equity or cash) that depend on hitting the budget or somewhere very close to plan.

So the risk of missing the forecast is real and tangible to everyone in the senior management of the company.

When a company has no revenues, this isn't a big deal.  And when a company has $50mm in revenues and is growing at 20% per year, its not that big of a deal.

But when a company has a couple million in revenues and is trying to double or triple that (in the "launch stage" before "escape velocity"), there is a lot of risk in the budgeting process.

And you don't want a team to miss the budget in the first half of the year and have no incentive to try for the rest of the year (like the NY Jets this year).

And then there is the issue of expense structure.  That needs to ramp in advance of revenue growth but how much should it ramp?  These are the kinds of decisions that are hard to make on an annual basis in a company in hypergrowth mode.

So a couple years ago Matt Blumberg and Jack Sinclair, CEO and CFO (now COO) of Return Path came to the Board with an interesting proposal.  They suggested that they develop an annual budget and four quarterly budgets.  And they suggested that at the end of each quarter, they develop a new quarterly budget for the next quarter and beyond, which is essentially a reforecast based on what happened in the current quarter.  The net of this was that we went to a rolling budget processs where there was a big budgeting effort at year end and a shorter one at the end of each quarter.

If you must forecast, do it often.

That approach worked great and got Return Path through several years of hyper growth, multiple acquisitions, and a changing business model and mix.  They have now moved to semi-annual rebudgeting and may get to annual this year. That's the goal of this approach, to grow out of it.

Since then, we have tried this approach with several other portfolio companies and are encouraged by everyone's receptiveness to it.

Forecasting is tricky business, if you must do it, do it often.

UPDATE: Matt Blumberg has posted his thoughts on this topic and his advice to entrepreneurs who want to give this approach a try is really solid.  If you are interested in how to do this well, go read Matt's post.

Comments

[Saffron Rainey]

A VC
Your point of forecasting is a topic discussed with useful hindsight by Ricardo Semler in his book Maverick! I think his experience would inform you to encourage your portfolio of firms to forecast often but not get stuck with the ambition of the large corporation's annual budget process. From memory all Semco's firms forecast on a semi-annual basis. Giving them the abilty to forecast both growth spikes and contraction shocks more effectively.
Regards
SR

[Don]

My portfolio companies are quired to work off of a living breathing business plan, and if they are not hitting their production/financial goals we look at it before it becomes a significant issue. I also ask that we do quarterly budget's based on the annual budget, which can alter the annual budget, so I tend to agree with you thoughts here. ;)

Don

[Les Trachtman]

While budgeting is quite an important (and extraordinarily time consuming) excercise, early stage (and in fact every stage) companies should be sure they realize the end game they are pursuing. The budgeting "game" for company executives should not be to determine if they met the "grade" so bonuses are received. Instead it should be an indicator as to whether the company has in place processes and procedures that can adequately forecast (predict?) outcomes of their resource allocation. If the resource allocation is changed (i.e., an acquisition, a changing market, a catastrophe, or otherwise, no one is foolish enough (not even an investor) to believe that the same "budgeted" outcome will result. What many execs fall prey to is that the budget is simply a yard stick for bonus payout. This type of focus can cause managers to make inefficient decisions that benefit themselves as individuals, but cause harm to the long term prospects of the company. Better to align compensation (both long and short) to be the same as the investors, rather than by intermediate adjustments to a budget, so that managers and execs are always incented to do the right thing - which may not always mean meeting or beating a budget, especially if assumptions have changed.

[Dan...]

Nice post.

Some thoughts on why forecasting matters here. [trackback failure workaround]

[Leigh]

argh.