Before a venture capitalist invests in a company, he evaluates the prospect from many angles. If he’s looking at an early stage investment, he will focus on issues ranging from the strength of the company’s management team and the market’s potential, to the applicability of the company’s intellectual property and the soundness of the company’s business model. If the prospect has moved beyond the startup stage, the venture capitalist broadens his scope to gauge how well the business is performing against its plan.
For these mid- to later-stage investments, profitability is an important measure of the business’s performance and growth potential. But it doesn’t tell the whole story. A company can have a great strategy and be generating profits, but the question remains: Is the company truly executing its strategy?
More often than not, venture investors don’t look far enough under the hood to determine whether a target is truly executing its strategy. This is more important than having a good strategy. It gets to the heart of the value of an investment and its probability of success. This is surprising, since a recent study concluded that 70% of organizations that have a formal strategy execution process in place report superior performance and only 27% of organizations without a formal process report such results.
Even more important than a well conceived business plan, the ability to execute strategy is what truly sets a company apart.
When a venture capital firm evaluates a company’s ability to execute strategy, what should it look for? Here are a few key facets it should try to spot:
• Financial systems and processes that provide visibility into performance and aligns finance to the enterprise strategy.
• Clear and consistent articulation of strategic direction and financial objectives.
• Allocation of resources and investment dollars in a manner that supports and aligns with strategic priorities.
• Attention to management processes that review strategic and financial investments and results.
A VC will increase his odds of generating an above-average return by asking the following four questions when evaluating a new investment:
1. Does the organization have a financial systems and processes to provide performance visibility and align finance to enterprise strategy?
More often than not, venture investors don’t look far enough under the hood to determine whether a target is truly executing its strategy.”
George McMillan, CEO, Palladium Group Inc.
Today, CEOs and CFOs expect Finance to help manage enterprise performance, to support growth and to deliver insight—i.e., to be a major contributor to executing strategy. Finance faces intense pressure to increase visibility and transparency, improve resource allocation, explain value drivers and address regulatory requirements simultaneously. As the custodian of an organization’s planning and forecasting process and systems, as well as corporate information resources, the CFO has the responsibility to optimize the process of resource allocation, accurately and clearly present results to key stakeholders and make the Finance function responsive to the strategy. Organizations with efficient financial processes and systems provide improved decision-making. Measuring the speed and accuracy of consolidation, closing and audit trail and controls is important. However, processes and systems should also provide financial rigor in developing strategic plans, provide visibility into the operational drivers of financial performance, monitor and incorporate internal and external changes to provide an up-to-date forecast on future performance, and provide management reporting to manage business results.
2. Does the organization clearly and consistently articulate and reinforce strategic direction and financial objectives?Successful organizations are led by executives who clearly define and articulate corporate financial goals and the main themes that will enable the organization to attain them. These themes will typically be structured around concepts in four key areas:
• Financial performance—what financial success will look like.
• Customer and market focus—which customer segments will be targeted with what value proposition.
• Internal capabilities—where should the organization focus with regard to product, customer and operations management?
• Key enabling assets—people and competencies, organizational culture and information capital.
Organizations that use strategy maps and Balanced Scorecards to define and communicate the above goals and strategies have a greater chance of success. A strategy map, for instance, depicts key themes and objectives on a single sheet, and another useful tool, a Balanced Scorecard, enables performance tracking and management within metrics of key performance indicators (KPIs). It is necessary to review these documents and processes to successfully evaluate prospective investments.
3. Is there an allocation of key financial and organizational assets around strategic priorities?
Successful senior executive teams ensure that capital allocation and discretionary budget funds are committed to programs that support and align with strategic priorities.
The need to allocate discretionary budgets and capital to key strategic priorities seems obvious for success, yet in many organizations the strategic planning and management process and the budgeting and capital allocation process are run completely independently of each other. In fact, research shows that 67% of human resources and information technology departments don’t link their priorities to the company’s strategy.
Successful organizations recognize the interdependence of the two processes and approach budgeting and capital allocation fully informed of the strategic needs of their organization.
Nine out of 10 organizations fail to effectively execute strategy, but one out of 10 succeeds. Companies that fall into this elite 10% group are the ideal targets for venture investments.”
George McMillan, CEO, Palladium Group Inc.
Support and shared service unit assets play a crucial role in enabling effective execution. It is critical that these units are aligned and integrated with the strategy and needs of their internal customers. Successful execution requires allocation of organizational and financial assets around strategic priorities.
4. Is there a focus on management processes, reporting and reviews that closely monitor strategic and financial investments and results?
Research shows that 50% of leadership teams do not spend any time on strategy review, and 85% spend less than an hour per month discussing strategic goals and objectives. Effective senior executive teams develop well-structured governance calendars and processes for managing strategy.
By building a reporting and review capability that provides continuing focus on strategy, asset investment and results, leadership teams can ensure that their individual and organizational focus is fixed on key objectives and the investments they have made to meet them. Ideally, teams meet monthly for four to eight hours to:
• Review performance against strategic goals and make adjustments to the strategy and its execution as necessary.
• Review progress on investments in programs designed to fulfill strategic and financial objectives and evaluate investment performance against budget, schedule and associated benefits.
Nine out of 10 organizations fail to effectively execute strategy. Yet one out of 10 succeeds. Companies that fall into this elite 10% group are the ideal targets for venture investments. Their ability to execute strategy gives them a significant advantage over their competition, an advantage that is showcased in breakthrough results.
In a situation where an investment target shows potential but is not executing on its strategy, a partnership with a venture firm could still work—under the right conditions. The prospect would need to work with the venture capitalist to bolster financial processes and systems, assess strategic readiness, lay out a roadmap for strategic improvement, and create a strategy execution team. This additional work would boost the company’s prospects by aligning the business to its strategy, resulting in an enhanced value.
Venture firms need to focus on the basics—proof of concept, validation of business models, market potential, differentiation, competition, business performance, cash flow, profitability and strength of strategy—when looking for places to park their money. But they can’t stop there. Companies that have sound numbers but are not truly executing their strategies may look good today, but they may not generate returns tomorrow.
The ability to execute strategy is what truly sets a company apart. Investing in a company that executes raises the prospects for a successful partnership that generates results for all involved.
George McMillan is chief executive officer of Palladium Group Inc. Prior to joining Palladium, he served as CFO and CEO of CMGI from July 2001 to August 2004. Before CMGI, he served as president and CEO for more than four years at BMG Direct, a unit of Bertelsmann AG. McMillan has served in executive capacities for more than 20 years and has spent the majority of his career leading and driving business growth in professional service firms. He earned his MBA with distinction from Harvard Graduate School of Business, his J.D. cum laude from Harvard Law School and his AB in Economics, Phi Beta Kappa, from Stanford University. He may be reached at george.mcmillan@palladiumES.com