Jim’s 4 Principles to Building an Operating Plan

by Jim Tholen, Managing Partner

We ask our entrepreneur CEO’s what are the driving assumptions underlying their business model projections (especially those they propose to share externally, including current and prospective investors)?

We hear all the time a refrain along the lines of: “Well we want to show the growth the investors have to see. So that is what I am showing.”

Other responses we get are similar versions of the above:

• “Investors need to see growth of x% so I need to show at least that”
• “I’ll only get a good valuation if we show this kind of growth” (the rejoinder is to contemplate your valuation after you miss that plan!); or
• “My current VC’s are pressing me for a more aggressive plan so that they don’t get diluted.” (we call this investors Goal Seeking your business plan)

…Yikes!

To us this is a great way to show a plan you have little hope of achieving. It is a bit of the inmates trying to please their prison guards.

Let’s refocus on how to solve this. We work with our clients to be much more inside-out (as opposed to outside-in) in thinking about how to present their company projections.

Think about developing and refining an operating financial business plan that both helps you better understand your business and enables you to describe, and set external expectations for, your business.

Our advice comes down to:

• Develop a plan you feel confident you can achieve!
• Know and use your business model and drivers. Base your plan on that model and those drivers.
• Use your plan and performance against plan to fully understand what is going on with your business holy trinity — bookings, revenue and cash.
• Build cushion for the plan for external consumption. Show an external plan that you know can achieve.

Some observations:

Especially with SaaS and subscription software businesses, it’s really important to model the bookings and revenue dynamics of your revenue stream. We’ve seen too many times people making top down revenue assumptions in a model and really do not reflect how SaaS businesses build revenue.

Equally important, the interplay of bookings and revenue are key to modeling cash, understanding customer buying behaviors and even compensating your sales organization. If you are a SaaS business and are smart enough to have your customers pay annually (or better) upfront your cash performance is very different then for SaaS companies who bill their customers monthly.

From an expense standpoint it is really important to understand how revenue growth drives your expenses.

• What drives your growth in implementation and onboarding resources (total billings? # of new customers?)? Your public cloud or other computing consumption? Customer support resources?
• Can these relationships be modeled? I think it is important to try — and continually measure actuals against your modeled relationships to refine your business model assumptions.
• And it isn’t just classic variable expenses. Revenue and customer growth can drive asset consumption as an example.

It is helpful to build these models with some level of bottoms up and roll-forward detail to project where you think you can drive the business. I think similarly valuable is to work through a high level aspirational long term margin model.

• In 5 years where would you like to see as a % of revenue: Cost of Sales and Gross Margins, Key operating expense areas — Sales, Marketing, R&D, G&A, and EBITDA or EBIT margin target

If you take that model and work backwards and compare it to your base model roll-forward — does it work?

In the end we are big believers in starting with achievable plans to manage your business and set expectations with your investors and prospective investors. Believe in your business by all means but don’t let those investors’ goal seek you into a plan you can’t achieve…