The Predictors of Significant VC-Backed Firms' Sales Growth

What levers can be pulled to ensure that every start-up from founding is going to achieve significant and sustainable sales growth? If every Venture Capital firm General Partner knew the exact answer to that question, they likely wouldn't be reading this, but joining Sergey Brin and Larry Page (Google founders) in the hot tub (see photo to the left).

Of course, ask 10 different people that question, on the keys to start-up success, and you're likely to get 10 different answers. But empirical proof is always more convincing than speculation.

With this in mind, two years ago, my consulting company began a collaboration with Dartmouth Tuck School Professor Sydney Finkelstein to build a diagnostic that could help predict (1) warning signs that an organization was veering in a direction that might result in major -- and potentially dire -- problems and (2) positive signs that an organization had its leadership, strategy, and processes lined up in a direction that would likely generate consistent and significant sales growth for years to come.

The first of those two goals came out of research conducted over 6 years in the writing of Syd's best-seller 'Why Smart Executives Fail'; and the second came out of research done in the last 3 years contributing in part to Syd's upcoming 'Breakout Strategy.'

The diagnostic (which we call the Breakout Performance Index or BPI) has now been used with over 150 organizations in North America, Europe, Asia, and Australia ranging from multinationals to early-stage venture-backed firms. The three major categories of leadership, strategy, and process, which we measured, were all found to be major predictors of increased revenues and increased market share across the entire dataset.

However, not surprisingly, there were differences across industries (and sometimes countries) in terms of which aspects of our 3 main categories predicted performance. One of the contexts which we have had the opportunity to study in some level of detail is the world of venture-backed firms. Later on this week, Syd will present the results of a recent study we completed on what we found to drive success in venture-backed companies at the Financial Services and Venture Capital Alliance Annual Meeting in Boston.

In the VC context, we studied about 30 companies (asking VCs who serve as directors on companies in which they invest, as well as Management Team members -- mostly the CEOs -- from VC-backed firms to complete the 75 question diagnostic). On average, the companies were 6 years old, had raised about $15MM in VC funding, had 50 employees, were doing about $10MM in annual revenues, with a 15 - 20% annual growth rate, and were just about break-even. Two of the companies in the dataset have recently been acquired (by Cisco and Alcatel) and one has gone out of business.

For those of you who cannot attend Syd's talk in Boston: here are the main results of our study.

1. How Much Venture Capital A Company Raises Does Not Predict How Much it Will Grow. This result is perhaps not surprising to VCs, who understand that likely only 30% of their investments will be significant 'winners.' But it is interesting that making bigger bets do not correlate with bigger outcomes.
2. 17 out of our 75 Questions (or about 25%) in the Diagnostic were Highly Significant Predictors of Increased Sales Growth for VC-Backed Firms. The difference between scoring at the median level in a particular dimension versus the top quartile often meant a difference in annual sales growth of 20% versus 100%.
3. The most important factors relating to Leadership found to predict faster sales growth were: Doing Annual Performance Reviews, Preventing Groupthink on the Management Team, Having a Spirit of Personal Accountability and a "Stakeholders' Mentality," and Key Management Team Structural and Process aspects (like attention to details).
4. The most important factors relating to Strategy found to predict faster sales growth were: Focusing on the Right Metrics to Measure Implementation of the Company's Strategy and Having a Compensation Plan for Management Team members aligned with the Strategy.
5. The most important factors relating to Process found to predict faster sales growth were: Having the Correct Organizational Structure in place, Ensuring that the Communication Channels within the organization allowed information to swiftly and correctly travel from the front-lines to the Management Team, and having a Strongly Motivated and Engaged group of Employees.

There are a number of take-aways from this study. The fact that such a high number of questions in the overall diagnostic predicted much faster sales growth is interesting -- and stands out compared to larger companies. VCs are fond of saying that the quality of management is the most important factor they weigh before making an investment, but this study sheds some light on what are the behaviors which management can exhibit to actually positively influence their company's performance.

If you are a GP, how would your investments do on the categories laid out above relative to their peers? If you are a CEO of a VC-backed firm, do these findings suggest you're encouraging the right behaviors on your Management Team and across the organization?

Ultimately, the most important performance metric for VC-backed firms is sales growth. This is usually what sets the value for the organization if it is later sold or goes public. This study suggests there are clearly some levers which you can influence to up your company's growth rate.

If you would like more details on the study or to find out if your firm would rank top quartile or bottom quartile on these dimensions relative to other VC-backed firms, drop me a line.

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