3 Operating benchmarks founders should bear in mind now.

Last week, I had the pleasant surprise of interviewing a genuinely egoless and insightful private equity investor. (Really. They do exist.) When I say insightful, I mean he spoke candidly and with a unique perspective on the PE trade, as well as on the tech industry (his area of focus). He also generously offered up a few of his “trade secrets” as tips for Found|READers regarding what investors look for in prospective portfolio companies. When I say he was egoless, I mean he refused credit for this “business intelligence,” insisting on anonymity (although this is just as likely because peers in his notoriously cloistered PE industry might mock him for opening his kimono).

While he asked that I not use his name, I can tell you that he is California-based and specializes in midsized software companies, with $50 million to $100 million in revenues, and a specific vertical focus (e.g. sales optimization for a special industry, and the like). So, it’s no surprise that this guy’s team has been active the last few years – they’ve done dozens of acquisitions, rolling-up most of their investments into a handful of companies which my source insists are “stronger, more efficient, and substantially more profitable” they were before. Now, I’m not one to just take a PE-type’s word for it, but the purpose here isn’t to review his IRR (too easy to game, anyway).

The point is the “trade secrets,” he agreed to share with Found|READers. Learned from one of his own mentors, they are actually a series of questions concerning operating benchmarks that he puts to each CEO at a company under review by his firm. Using them, my PE source says, has significantly advantaged his firm’s successful investment decisions in a very crowded software space: If a CEO can’t answer these questions right off the bat, his firm isn’t likely to invest in the company.

He wouldn’t reveal all of the questions in his litmus test (there are 10), but he did share 3 that he considers most important. If you can’t answer these queries with ease, your house is not in order. Think of them as a guide for good management. Commit them to memory.

3 Operating Benchmarks for Founders:

1) Are all your customers on 1 level of support, or 3 different levels of support?
Explanation: If you don’t know this, you don’t know your customers; you don’t know your business. BTW: one level of support is better than three.

2) How are the statements of work processed through the company, and between departments?
Explanation: If you can’t answer this, you don’t have good communication within your company. Chances are the left hand doesn’t know what the right hand is doing, which is bad. Investors don’t like this.

3) What percent of sales quotas/goals are used to budget/forecast the company’s revenues?
Explanation: How efficiently do you manage your sales productivity? How conservatively do you budget? How big a cushion to give yourself?

Even though most PE guys buy comparatively mature companies, not startups, we think Found|READers will benefit from keeping these questions in mind as they operate their businesses today. After all, many founders might have to consider selling to a PE shop down the road, so founders might as well know what investors (some of them, anyway) will be looking for in a prospective buy.

Rate This Story

Become part of the community! Register or log in to rate

Average rating:

Talk About This Story

Chris Merritt
(1 point)
September 10, 09:09 pm

Nice post … thanks. Would love to know the remaining seven questions, but these provide plenty of “food for thought.” In my experience (at much smaller, but growing, sw cos.) is that: for (1), that you might like to distinguish between “high profit” and “high cost” customers, but in practice it’s too difficult, esp. if you’re small / just starting; for (2), a lot of thought needs to go into streamlining a process and, much like my garden, it needs constant pruning; and for (3), using different %ages at different stages (suspect, prospect, contract negotiations, etc…) provides a pretty good picture of where you’re likely to end up.

Anyhow, good stuff … thanks.

Hasan Luongo
(24 points)
September 11, 08:09 am

These questions are good awareness factors for CEO’s, but I do not understand all the secrecy. No offense but PE investors are not the wise sages of all things business and investing.

They should take a hint from the VC bloggers and open those gold threaded kimonos a bit more. Shrouds of secrecy means there is something to hide.

Become part of the community! Register or log in to comment