Finding the Right Balance in Board-Approved Plans

Darrell Sorenson, SVP, Technology Banking, Pacific Western Bank

Seasoned Lenders see it all. The sand-bagged plan. The overly aggressive (and unrealistic) plan. The copy/pasted plan using internal sales goals without pushback from CFO. The prescriptive plan from the loudest board member. The plan that doesn’t reflect recognized revenue from booked ARR.  The revised plan emerging only after difficult conversations around revenue or headcount (growth or cuts).

Lenders appreciate seasoned CFOs because they’ve navigated multiple situations, can avoid potential mistakes in plan creation, and more importantly communicate proactively with stakeholders.

Darrell Sorenson, SVP at Pacific Western Bank’s Technology and Venture Banking Group believes that management should carefully manage expectations at the board level, build consensus around an achievable plan that makes sense within the context of cash runway and performance needed to attract future equity.

Does a sandbagged plan ever make sense? Perception is reality without proper context. Lenders might suspect a sandbagged plan if growth (% or $) is projected to drop year over year, particularly if the plan is provided just prior to setting a financial covenant (could be perceived as a way to make the covenant loose).  However, if a Company finds itself consistently missing plan by a large margin, an aggressive plan only sets up stakeholders for disappointment and might unnecessarily make internal folks miss bonus targets.

Aggressive plans. An aggressive plan can sometimes justify planned investments in S&M or R&D headcount; missing that plan can, in turn, make subsequent cuts more likely. 

Lenders benefit from speaking with CEOs because it is often a CEO’s drive and passion that wills a Company’s vision into reality. However, Lenders tend to rely on information from CFOs (or VP Finance) who are naturally more conservative in forecasting.  Seasoned CFOs know when to push back with the CEO and board members in order to provide a more realistic outlook.  And while engaged investors will often have a closer pulse on the fundraising environment and what level of performance will be needed to attract a new financing round, management should have working hypothesis, and understand the trade-offs of growth and burn and approach forecasting and financial projections to avoid existential threats (i.e. growing topline, without driving value, or burning too much relative to growth, or gross profit gains).

"Lenders Benefit from Speaking with Ceos Because it is Often a CEO’s Drive and Passion that Wills a Company’s Vision into Reality"

CFOs, CEOs, and boards are tasked with providing internal and external stakeholders realistic and helpful forecasts and board-approved plans. Challenges abound particularly in transitionary times in the equity markets or when a historically high growth (and high burn) Company starts to slow growth, or loses a large customer contract.  Management and Board Members might haggle around in what part of the org to increase/decrease headcount, how much should the Company lean into growth (burn, or spend ahead of the revenue/collections), how aggressive of a plan should exist when external stakeholders include a Lender? 

Lenders develop ‘pattern recognition’ and will naturally have questions around steep investments in headcount/burn, when bookings/revenue are not growing similarly.

Plans calling for very high growth, might be met with performance skepticism, whereas a plan calling for much lower revenue/growth vs. previous years might be met with skepticism around sandbagging, particularly if the plan is provided directly before a covenant setting negotiation is about to occur.

In the case of increasing burn, but without a similar uptick in revenue, be ready to explain why this makes sense.  In the case of high growth, yet tightening liquidity, a Lender will want to understand what level of performance is needed to attract incremental equity (to support that growth).

In any event, management should carefully manage expectations to build a consensus plan that management wants.  While VC board members get a ‘vote’, VCs are often led into a what management has been selling the board on, along the way. This means that VCs don’t actually have as much ‘control’, at least in situations where no shareholder has a majority, or where there aren’t strong reasons to exert said ‘control’.  However, the more reliant on future equity (from existing or future VCs), the more a plan (and performance) needs to make sense in the current equity climate. 

Sometimes the loudest voices in management or the board steer the conversation; sometimes rightly so. For example, when the equity investment climate changes or when slowing growth no longer justifies the burn, which the realization is often accompanied by a RIF (reduction in workforce) and a revised board-approved plan. Or the investor with the greatest amount of reserves for future investment or greatest ownership % (not always the same thing) might have a strong opinion on how aggressive or conservative to invest cash into growth.  Lenders will often want to understand board (equity) perspectives as well as from management.

For cash burning companies, proactively staying abreast of market trends, required performance to attract equity should always be a consideration. Sometimes, board members (yes, even venture capitalists) can be slow to react with cuts (or additional investments). 

Management teams are sometimes influenced by the Board (VCs) to increase revenue targets, however, signing themselves up for an unachievable plan, doesn’t help anyone, and can hurt morale.

Another issue in practice is where a sales-oriented CEO (or board) doesn’t get enough pushback from a CFO, and the sales goals are essentially memorialized, without buffer, into the board-approved plan. The result is often a less than happy lender or other stakeholders and sometimes missed bonuses by the management team and other employees. 

Financial