What does it take to get out of the ‘spend now, think later’ cycle, asks our Entrepreneur in Residence Glenn Elliott.
There’s a lot of new territory that comes with becoming a private equity CEO. With external shareholders, suddenly there is a discipline you have to get into. They want to predict what you’re going to do and want to have a say in your decisions.
It’s a new way of working. You might never have done a budget before, let alone one that spans multiple years and won’t account for the good ideas you’ll have along the way. It’s frustrating when you can’t execute those if they come as an unexpected dip into your meticulously planned budget.
Yet once you realise the impact of your decisions, you can still be creative, without falling into an irreversible ‘spend now, think later’ pattern. That’s how I managed to get a handle on the three biggest budgeting mistakes I made as a CEO. Here they are.
1. Not realising the full impact of prior year decisions
When you’re a private equity-backed business, you’re going to agree a plan with your investor to grow profit over the cycle. While I was running Reward Gateway between 2010 and 2015, our model was simple. Every year we wanted to add £3 million in revenue. By adding £1 million in costs to improve the business, we would increase our profits by £2 million.
As the year goes on though, you come up with more ideas that aren’t in your budget, which typically involve recruiting. You think, let’s do it, because, the further down the year, the less a new person will cost. If you do the maths, an extra marketing person at £35,000 per year costs roughly £3,000 per month. If you hire them with two months left, it’s only going to cost you £6,000 this year.
But then what happens is in the next financial year, you have the full year impact of that prior year decision.
In this situation, you have to do one of two things. You can either put a halt on further costs, or persuade your shareholders that, in the next year, you’re going to have lower EBITDA. You can tolerate this better in the earlier part of the private equity cycle rather than towards the end.
To break it down, in the first six months you want everyone to settle down and get used to the new people on the board. Then in month six to 18, you start looking at what investments you want to make to grow faster, and you’re trying those out in years two to four. As you get to year five, you’re thinking about selling the business, so you’re in tidying up mode.
2. Accounting for a new hire’s salary – and only that
You might put £35,000 in your budget for a new marketing person…then forget to put in another £35,000 for them to spend. You might also forget that growth in your marketing department can mean also needing more designers and writers. Otherwise, you end up with a marketing person with no money or resources to do a good job.
This is why companies often have a shortcut of salary plus 30%, which might cover tax, National Insurance, training, travel and expenses budgets – the ‘fully allocated costs’ that HR departments are good at.
That doesn’t always solve the problem, though. Say you agree with your board to bring in a new six-person sales team to generate more revenue. But how does that sales team work? What are they going to rely on to be successful?
A sales team needs leads. Leads come from marketing, who now has another sales team to feed. So then you might need an extra person to do demand generation. But then what do they rely on? They might run campaigns to generate leads, so does your creative team have enough capacity to support?
Similarly, you might invest in building a new product. But have you thought about who’s going to market and sell it? A product is only valuable to the company once someone has bought and paid for it.
It’s a mistake I’ve made several times – to look at a project at face value, rather than pausing for longer, and working out all its dependencies across the business to make it really work.
3. Budgeting at haste…and repenting at leisure!
It might be tempting to rush through your budget and promise a lot to your private equity firm. Investors have high expectations. They want your business to grow fast and know your ideas for that, so you can get caught up in the wind of it all.
It’s important to understand early on what your private equity firm expects the business to do in terms of profit. Then, it’s better to spend more time in the budgeting phase to make sure what you’re presenting is achievable.
Because in private equity, if your budget falls short, everyone scratches their heads and asks what went wrong. If you hit your budget, everyone’s happy.
Pruning for profit
Nobody likes making people redundant or cutting things back – most people I know will do anything to avoid it. But unfortunately, asking if a particular product, department or person is still needed is a key part of sustainable, profitable growth that can also be overlooked.
Think of it this way. If you did three big growth initiatives every year, you’d have 15 in five years. You’ll be lucky if five work, but what will typically happen is you won’t turn off the 10 that don’t.
For example, we had several products at Reward Gateway that were going nowhere, but we had about 10 big clients using them that were hard to disappoint. If you create a new product that doesn’t take off, the brave thing to do would be to shut that down and divert the resources elsewhere. To be honest, it was the CEO after me that cancelled those products that weren’t working, which I should have done.
Having someone on board to question your decisions, and analyse whether the things you’ve introduced are actually working, can go a million miles towards avoiding the most common budgeting mistakes you’ll make as a CEO.